Wednesday, 13 January 2010

The Rise Of The China-sceptic.

Every now and then, a novel idea enters the public domain. At first, that idea sounds a bit off-beat – almost revolutionary. Eventually the idea is taken up by more and more people so that it manages to reach the mainstream. Beyond that, if the idea gains traction, it becomes part of a new conventional wisdom. Once there, anyone who questions the idea is seen as something of a crank. The ideas behind the rise of China fall into this path. Originally, at the turn of the century, the notion that China would be a rising super-power was seen as fanciful. The then conventional wisdom of the Washington Consensus had no place for China.

Goldman Sachs questioned that conventional wisdom when they developed the notion of the BRIC economies. Over the course of the decade, as the BRIC economies grew relative to the OECD economies, so the notion took hold. It has now reached the point where it has become the conventional wisdom. I attend a number of futurist meetings each year and at each one I am greeted by the mantra that China will have the largest economy in the world by the 2020s. Personally, I very much doubt this.

My cause for scepticism is threefold. First, there is the question of demographics. The ‘One Child Policy’ has served China well to date but, at some point in the coming decade, it will go into reverse, giving rise to a sharply growing dependency ratio (the ratio of working population to non-working population). Unless China experiences a very high level of labour productivity growth to compensate, as the size of the working population falls, so GDP growth will come off the boil. The decade may witness the reduction of GDP growth in China to the 5% to 8% band.

At this point the second cause for scepticism assumes importance. As time goes on, the law of large numbers will start to act as a constraining factor to the Chinese economy. High growth rates are easier to achieve when the economy is relatively small, but much harder for a large economy to maintain. This is why the growth rates of the BRIC economies are much higher than those of the OECD economies. For example, the raw materials that are needed to run the Chinese economy at it’s present levels have caused most markets for raw materials to tighten. At some point during the next decade or two the demand for those raw materials is likely to exceed the capacity to supply them, acting as a limiting factor to further growth.

Third, to close the feedback loop, China has a very high savings ratio – mainly in response to the absence of a welfare safety net, as most Europeans would understand it. The private sector is saving through bank deposits, which are, in turn, being lent to fuel property and stock market bubbles. Usually, the creation of such bubbles suggests a lack of productive investment opportunities and foreshadows a financial crisis as and when those bubbles burst. Any slight disruption to the Chinese economy could lead savers to ask for their money back, precipitating something of a financial crisis. Given that the Government of China has deposited its surplus funds in US Treasury Bills, there are grounds to suspect that financial contagion could spread quite quickly. If that were to happen, then the overtly nationalistic policy of the Chinese Government could well hamper a co-ordinated global monetary response to contain the contagion.

This is not to say that we are predicting the financial collapse of China. What we are saying is that the development of the Chinese economy is a lot more fragile than it appears, and that an uncritical view of the conventional wisdom does not encourage a balanced review of future prospects. It is correct for futurists to point to a trend of China becoming a greater economic force in the world. However, good futurists would also point out that for every trend, there is also a an important counter-trend that could well turn into a new conventional wisdom. Over the past few months, I have noticed the growth in the China-sceptics. More and more articles that question the conventional wisdom are being published (I have included the links to a couple below), which suggests that we might be seeing the start of a turning point.

Only time will tell if the case for China has been over-made. However, given its importance, I think that it is an issue to which we will return from time to time.


© The European Futures Observatory 2010

Contrarian Investor Sees Economic Crash in China (New York Times 07/01/2010)

Think Again: Asia's Rise (Foreign Policy, July 2009)

Tuesday, 5 January 2010

Scarcity Bites – A Decade Too Soon!

The twin concepts of scarcity and plenty describe a complex relationship between what we have and what we need to have if we are to do everything that we want to do. In many respects, one aspect of the future that will enter into our consciousness in the very near future is that of scarcity. In simple terms, scarcity suggests that the supply of a resource is not sufficient to satisfy its demand. As the global population increases, and as that population has expectations of higher living standards, so the demand for resources will rise. However, as we start to feel the finite nature of our resource endowments, scarcities will start to emerge. This is the underpinning of much thinking on the issue of ‘Peak Oil’.

It is our contention that energy is not the only resource that will be scarce in the immediate future. We envisage scarcities of food, water, and a whole variety of minerals that are crucial to the operation of a modern economy. Our thinking so far has focussed on the 2020s as the decade in which scarcity starts to be felt (we call it ‘Scarcity Bites’), but recent events have drawn our attention to a much earlier manifestation.

A recent article in The Independent (see below for link), has drawn our attention to the case of the Rare Earth Elements (REEs), a group of 17 rare metals that are essential to the manufactures of the modern economy which are in a situation of scarcity (demand outstrips supply). The picture is further complicated by China being the main source of the REEs (it supplies over 95% of the world total of REEs) and following a policy of restricting their export. This conjures up some fascinating possibilities for the future.

The onset of scarcity is likely to lead to a large spike in the price of the scarce resource. In many respects this has already happened for REEs. The spike in price will have three important implications:

  1. Alternative sources of the scarce resource that have been abandoned as financially unviable will be reappraised, some of which will now be viable, and will then return into production.
  2. The high cost of the scarce resource will be sufficient to stimulate research into viable (i.e. less costly) substitutes for the scarce resource, some of which will be viable and help satisfy the demand for that resource.
  3. The high cost of the scarce resource will encourage users of the resource to be more parsimonious in their use of the resource. This will act to assist the conservation of the resource to elongate its supply.

As the demand and supply for the resource become tempered, the price will fall back from its previous high to a new, more stable, price. This is a standard analysis using Marshallian Time Periods.

The monopoly of production in China is a complicating factor. The production of the REEs has no value to China per se. Their importance lies in being a constituent part of a number of key manufactures. In many respects it matters little outside of China if the REEs are exported in mineral form or in the form of embodied manufactures. China has enriched itself on being the global source of cheap manufactures.

This only works as long as the manufactures are cheap. However, the embodied REEs, as a small constituent cost in the manufacturing process, can increase in price substantially before they have an impact on the overall price of the manufactures. For example, suppose that we have a good that uses REEs, costs £100 to manufacture, and the REEs represent 1% of the manufacturing cost. If the REEs were to treble in price, the manufactured cost would only rise to £102, a 2% increase in the cost of the manufacture after a 300% increase in the cost of the REEs.

Economic theory would suggest that we ought not to worry too much about the scarcity of REEs starting to bite. As a small component cost in the overall manufacturing cost, the increase in their prices is unlikely to have a major inflationary impact. It is likely to stimulate production elsewhere in the world (Australia and Greenland are two contenders), thus lessening the monopoly of China. Viable alternatives to REEs will become more attractive, and the relatively high cost ought to make us conserve the stocks that we already have. However, this is a case of scarcity becoming evident a decade sooner than we thought that it might. Either way, it should be an interesting case study for the onset of more serious scarcities (Food, Energy, Water) later in the century.

It appeals to that part of me that is a small boy with a beetle in a jam jar!

The issues covered in this post are dealt with at greater length in our forthcoming book “The Age Of Scarcity 2010-50”.

© The European Futures Observatory 2010

Rare Earth Elements:

China and REEs: