America's hundred-year challenge: China and the avoidance of conflict with it.

Monday, January 5, 2015

The AMCHAM Canada "State of America" Series: A series of articles and commentary on issues related to the state of economic, political and business affairs in the United States 

Contributors: Adam Daifallah - Stephen Kelly - John Parisella - Élisabeth Vallet - Tom Velk - Donald Cuccioletta

Number 10 - January 5, 2015

America's Hundred-Year Challenge: China and the avoidance of conflict with it
by Tom Velk and Olivia Gong

In the past, when great empires have sought to occupy the same point on the planet’s timeline – Athens and Sparta, Rome and Carthage, England and France, Russia and America – the result is often conflict. In contrast with this historical reality, Immanuel Kant advanced an optimistic theory: he argued that nations which take advantage of opportunity to benefit immensely from trade, mutual investment and economic comradeship are motivated out of anticipated gains to maintain peaceful relations with one another. But every Civil War and every history of combat between neighbors shows that short-sighted political leaders will sacrifice the interests of their children in order to gain the benefits that come from the immediate capture of the figurative common warehouse of seed corn intended for a shared harvest. The great philosopher perhaps closed his eyes to history when he made his evaluation of mankind’s ability to distinguish between the short and long run.

The challenge of the next hundred years is to create a social, political and economic condition that will save the world from the dire consequences of combat between China and the United States.

A list of profoundly important variables must be in the most delicate balance: public opinion, intellectual leadership and political sophistication. If wisdom prevails, they can be combined for a nation to take strategic advantage of the situation. With luck and perseverance, a healthy partnership between East and West could take shape and the happy (but otherwise naïve) optimism of Kant might accurately describe the future of the world order.

China’s Economy at a Glance

The Chinese economy has grown too fast, too big and too significant to ignore. The total value of the goods and services produced in China $17.6 trillion (approximately RMB 109 trillion) now exceeds, by three or $400 million, the comparable value for the United States of America.

Beginning only three decades ago, China developed and recently made open to the rest of the world (via monetary gateways in Hong Kong and Singapore) modern stock and securities exchanges, networks and markets. A reasonably modern, albeit government influenced banking system has for some time been available to China’s large firms and quasi-government financial entities. But just within the past few months a modern semi-retail banking system is becoming available to China’s ordinary citizens, small businessmen, and household level investors.

China’s brightest young people, in the hundreds of thousands, have taken advantage of educational opportunities in the West. Their intellectual, professional and technical abilities are the stuff of wonder and envy on every campus and research institution in the rest of the world.

Resentment and Social Tension

But the great wealth that has grown up in China’s trading community, coastal cities, banking houses, investment community and professional elite is beginning to stir some resentment among Chinese citizens whose bad luck it has been not to be engaged in the machinery of export led growth.

Disequilibrium among these “left-out” persons and communities, some of them are located in the Western part of the country, in the agricultural sector, as well as in parts of the Chinese nation yet to industrialize have motivated the Chinese leadership to move away from its commitment to export led growth and to realize that the future requires, at least in part, a focus on consumer goods production intended for internal growth and development. There will then be a consequent reduction in economic envy and class antagonism. 

China’s Capital Account Problem

China’s multi-trillion dollar pool of foreign exchange reserves, far too much of it in the form of bonded indebtedness on the part of the United States and the West is being reallocated into investments in equity positions – direct ownership of producing assets located all around the rest of the world. This strategy is rational in a number of respects: no investment portfolio should be as heavily weighted as China’s once was in debt and bonds. The portfolio was notably short in equity, property, commodities, ownership, as well as intangibles like human capital, finance and intellectual property. The necessary addition of such assets to China’s international capital account will give it better control over its own future, and powerful influence over the planet’s future.

China’s long run need to build a consumer society alongside its manufacturing sector required equity positions that are long-term. It is important that input prices be steady. The stream of inputs necessary to feed China’s modern industrial empire must be uninterrupted. And so China chooses not to buy oil by the barrel but by the oilfield, lumber not by the board but by the forest, iron not by the ingot but by the mine. That was the beginning. The next step is to move up the figurative economic food chain: with the iron and copper in hand the next step is to acquire an auto manufacturer or home appliance maker; next a banking house to secure added funding, next a great research institution (remember Bell Labs?) – All the way up to the Waldorf Astoria hotel, (to house visiting owners on inspection trips??).

Agents of Change

Meanwhile, the Trans-Pacific young professionals, technocrats, engineers and financial whiz kids, including Westerners who can operate in both cultures, form the human components of the integrated web of ownership, control, management and strategic planning that will – potentially – guide and design the integrated partnership – East and West – that will carry the planet’s population to the 21st Century’s possible high plateau of economic development. It is the possible (if not entirely probable) road to Immanuel Kant’s better world.

Tackling Inequality: World-wide Income Distribution

Trade and partnership between East and West will accelerate the improvement in world-wide income distribution. Economists have a name for it: the Heckscher–Ohlin model (H–O). Trade and investment partnership makes the aggregate economic pie larger, because the enlarged market allows consumers to demand better, cheaper choices and it provides sales opportunities for the most efficient suppliers. But it does put inefficient players out of business. East West trade has rewarded Western bankers, managers, organization-makers who dominate the entrepreneurial side of world trade, and especially who have replaced (sometimes to great political advantage for all), in the East, the highly inefficient bureaucrats,politicians and (sometimes) despotic rulers who, in the recent past, combined raw political and social power with economic dominance. So arbitrary rule and irresponsible power has diminished (not disappeared) in the East, while managers and organizers, mainly from the west, have prospered. 

There is little doubt that ordinary western workers, especially least skilled, do not compete effectively with Eastern labor. There is likewise no doubt that workers in the East have, in the hundreds of millions, left rural drudgery, village poverty, and technical primitivism, while moving into modern factories where wages, be western standards, are low, but, in the East, where economic rewards are much greater than ever before. This is H—O at work. In the developed nations, capital (often human capital) in the form of managerial skill, financial sophistication, and legal subtlety has enriched “the Top”, while low income people and firms who cannot compete with Eastern productivity and costs, have lost out. But the planetary numbers favor the East--- hundreds of millions of Eastern persons are lifted out of the most abject poverty imaginable, and new management techniques imported from the west have eliminated large numbers of incompetent, ideologically-motivated corrupt, petty economic tyrants. Yes, in the West the most inefficient low wage workers have been displaced, and top players experience new sources of profit as markets expand. But in the West, economic safety nets exist to a degree unknown in human history, and taxes and burdens place upon “the rich” are present in abundance.

Solution: What Must Happen in the Future

What evolutionary changes could go on, maybe must go on, in the West, so this integrated, partnership might yield its full potential benefits? To what extent is Western participation needed by the East? The commonplace observation is that we in the West may “teach” rule of law standards and habits to the East. “Teach” is the wrong word. But a form of rule of law may be exported, in part, by the West as the partnership possibility unfolds. In small incremental ways, as each equity investment is consummated, elements of firm-specific business law, company law, bank law, financial habit, corporate legal department managerial rule book law will be absorbed into the Chinese business culture. International economic entities that now orbit around China’s financial star long ago evolved a de facto law-like collection of managerial traditions, full of the subtle sophistication produced by their long experience dealing with customers, unions, regulators, stockholders, lenders, bankers and media curiosity seekers. Such business-like habits and practices, in quite a natural and piecemeal way, “seep out” of western firms and begin to effect internal Chinese organizational practice. As well, managerial habits acquired as they studied and trained in the west, will mold and shape the personal experience of human “agents of change” whose career path carried them, back and forth, constantly re-crossing the Pacific.

As long as Western governments avoid the temptation to inflate away the “burden” of China’s remaining bond investments, as long as we do not resort to economic nativism when foreign equity investors acquire a greater degree of ownership and control of producing assets (we may properly insist that increased efficiency and diminished monopoly power characterize the result – and it will be in China’s long run interest to give such assurance), and as long as our educational institutions remain technically competent, we will profit. We certainly will enjoy a better outcome than the one which would result from conflict.

In other words: on the part of China, their population of returning “agents of change”, occupied as owners of newly acquired equity investments, will oversee the distribution of consumer goods to China’s current Have-nots. With economic improvement will come political consciousness and interest in self-improvement as well as a desire for self-government. That is, the simple needs of consumers as well as workers in a consumer society driven by economic choice and profit-seeking will lead, at least in small ways, to an interest in social and political options. Banking and financial institutions – of Chinese design but using tried and true mechanisms for “business law and control” – will lead the way. Western managers, especially those experienced in business law, company law, and all forms of management of the balance among managers, owners, lenders, workers, customers, regulators and competitors, will assure that the West, as it loses some degree of equity, will remain in charge of, or at least continue to have significant influence over, operating rules that will govern the next steps in the shared economic, political and social evolution of the East West partnership process.

Perhaps this sketch of a possible Shared East West future is unduly optimistic. Certainly Kant’s vision, which partly inspires ours, turned out to be mistaken. We can only say our vision is reasonably possible, and certainly better than combat.

Tom Velk is an American economist and Director of the North American Studies program at McGill University. He has served at the Board of Governors of the American Federal Reserve System and has served as a consultant to the Joint Economic Committee of the United States Congress. Mr. Velk is a regular contributor to media coverage of economic issues for The Wall Street Journal, the Canadian Forum, The Globe and Mail, Financial Post, Montreal Gazette, Le Devoir, and the CBC.

Olivia Gong is a Bachelor of Commerce student at McGill University, Class of 2015.

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