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Thursday, January 20, 2022
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China’s Apparent Strengths Are Really Weaknesses

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Journalists and commentators make the same mistakes about centralized economies, and they do so over and over again. First, they stand in awe of the grand plans presented to them by such nations. They marvel at the ability to marshal huge economic resources to particular goals. Then, as the evidence of failure mounts, the reporters move on to wonder in the same ways at another centrally planned system. They refuse to learn: centralized planning is a weakness not a strength. 

In the 1950s and 1960s, journalists frequently stood in awe of the Soviet Union’s ability to organize for the production of steel and heavy equipment. Many at the time referenced the plans that enabled this and forecast communism’s ultimate triumph, even as they disapproved of the system. In the 1980s, Japan, though far from communist, inspired similar wonder at its top-down approach to economic organization. Tokyo’s Ministry of Economy, Trade and Industry (MITI) produced what seemed like unbeatable guidence. That system, too, failed to dominate the world as forecast. And now it is China’s centralized economic direction that produces the same praise and fear among a new generation of journalists and commentators. China may do better than the two previously unbeatable economic efforts, but if it does, it will be despite its centralized economic direction not because of it.

These writers can be forgiven. When a nation focuses itself on particular economic purposes, things can look very impressive, especially because the target activities typically occupy the headlines of the day.  What else would planners emphasize if not the hot industries of the moment? The Soviets’ aim at steel and heavy machinery looked insightful, coming as it did on the heels of the Second World War. And in a relatively short time, the Soviet Union was indeed producing more of this stuff than did America’s decentralized economy. With Japan, the matter was more nuanced. Its focus on efficient cars seemed right in the energy crisis of the time as did MITI’s desire to dominate the then new world of electronics and personal computers. Similarly, China’s centralized system has settled on today’s hot products. According to Premier Li Keqiang’s “Made in China 2025” plan, that country seeks dominance in biotech and artificial intelligence as well as aerospace and electric vehicles.

The problem for the Soviets’ and Japan’s centralized focuses, and perhaps ultimately for China’s, is that forecasting is simply impossible. Todays’ headlines are by nature about what people think is important now.  But tomorrow’s needs may demand very different products. The Soviets, for instance, made their massive steel and heavy machinery effort when a lot of other centralized efforts were doing the same thing. By the time they came to dominate, the world faced a glut of those products and a glut of production facilities for them, especially when in the 1970s the energy crisis did so much to alter economic priorities. Japan did well with cars, but its electronics emphasis centered on the straightforward silicon chips that when MITI made its plans ran all what today look like simple devices. But even as Japan’s effort at chip dominance gained momentum, Intel in the late 1980s introduced the first microprocessor. It paved the way for smart phones and today’s much more sophisticated personal computers and iPads. It also left Japan completely dominant in chips that few people wanted any more. All these failed efforts at dominance produced great waste. China’s picks may be right for the long-run future, but there is no telling now, and it would be more luck than insight that produced success.     

Of course, American industry also plans and is often wrong. Sometime those mistakes produce considerable waste. But because the United States does not run on a centralized plan, those wasteful mistakes are not nearly as grand as when a whole nation’s focus goes wrong. Generally in America’s system, some companies follow today’s headlines, others refuse and stick with the past, while still others, following some particular insight and pursue something entirely different. Those that refuse and stay in the past lose. Those that follow today’s headlines can win to the extent that those headlines capture the future. Those that go their own way may lose, but if they capture the future, they win big, for themselves and for the economy generally. The mix of bets never creates the awesome sight of all the nation’s resources marshaled for one or two tasks, but it has three important virtues: It relives the economy of the great waste of an incorrect centralized decision. It allows room for more experimentation. It makes it more likely that somewhere in the business mix, someone really will capture the future. 

China may get lucky. The pace of change in fashion and technology may slow so that today’s emphasis and all the resources dedicated to pursuing it pay off. Then the Middle Kingdom, as China calls itself, will surpass America and its less centralized less targeted approach. But for that to happen, China would have to improve on its record. To be sure, China has made great strides, especially early on when its needs were obvious: roads and rail links as well as ports and housing.  But as that economy has become more developed, it has become more difficult to know what to emphasize, and mistakes have become more common. Centralized guidance has built empty cities and high-speed rail lines to nowhere.  Each mistake has created a good deal of waste, and because each effort, successful or failed, has required considerable investment spending, all these projects have left a legacy of debt, which the successful efforts can pay off but which the failed efforts cannot.

Because so much has failed, the debt has accumulated. Although Beijing has kept a lid on government debt issuance much better than Washington has, that debt alone is inadequate as a measure of this effect. Unlike the United States, China’s communist government runs its provincial and local governments like branch offices and owns the bulk of China’s industry through state owned enterprises (SOEs), for which the United States hardly has an equivalent. To see the errors wrought by China’s system and make a valid comparison to the United States, the debt to track is a combination of central government obligations, provincial (or state) and local obligations, and the debt of the corporate sector. 

These calculations are compelling. During the ten years through 2019, this broad measure of debt in China grew at a 23% annual rate, far in excess of the nominal economy, which grew at about 8% a year. The difference offers a rough (very rough) estimate of the waste created by centralized mistakes. The equivalent debt aggregate for the United States shows that the less centralized approach, if it has made mistakes, has made them on a much less grand scale. In America, this measure of debt has grown at about 5.6% a year over the ten years ended in 2019, faster to be sure than the 4% average growth of the nominal economy, but a much narrower gap than in China. The relative burden of these debt legacies is apparent in debt levels relative to the overall economy. In the United States, this composite of debt outstanding amounts to just under 180% of the country’s gross domestic product (GDP). In China, that figure verges on 220%.         

China has prospered despite all the errors and the waste they have created. Much of those gains arose because earlier in that country’s development process needed directions were obvious. Now that those directions are far less clear, the centralized system will become increasingly prone to mistakes and has accordingly increasingly burdened its economy. Those journalists and commentators who pin Chinese success on its ability to marshal resources have missed the point. That tendency is a weaknesses, not a strength.

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