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[Music]
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[Music]
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Marshall, thank you so much for joining
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us today. My pleasure to be with you as
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always. Well, as you know, uh, November
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2011 was the 10th anniversary of, uh,
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China joining the World Trade
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Organization or the WTO. So, why don't
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we start with a very simple question.
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What has joining the WTO meant for
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China? The short answer is everything.
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The changes in China have been quite
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dramatic. You can see the inflections in
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virtually every plot of the economy that
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you lay out. Um the obvious changes uh
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trade has gone up as a consequence of
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trade. GDP has gone up um as a
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consequence of uh the concentration of
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trade
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uh in the coastal cities of China,
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especially the special economic zones.
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The migration of uh peasant workers from
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countryside to city and back has
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increased enormously.
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Um one thing that uh another small
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inflection point interestingly is that
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the rural urban income gap
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um it didn't decrease but it stopped
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increasing rapidly about the time of WTO
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I assume as the result of wages
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remittances uh to the migrant workers.
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So overall this has had an enormous
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impact uh on China probably far greater
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than anybody anticipated. That that
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leads to the the next logical question
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is are there some sectors in China that
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benefited more uh than than others as a
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result of China joining the WTO? And
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were there actually other areas of the
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economy that may have suffered because
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of it? Yeah, there are actually some
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losers in this. There are some
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spectacular winners. The the big winner
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of course we know is manufacturing.
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Within manufacturing the big winner is
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electronics. China's biggest export is
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um electronic goods, computers and the
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like. Um uh not needle goods uh anymore.
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Uh these industries have burgeoned. Um
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much of the work of course is assembly
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work like Foxcon is doing for Apple and
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others. uh but uh but a lot of the work
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is uh manufacturer of of components and
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modules things like power transformers,
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electric cords, so on and so forth. So
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the manufacturing sector in general
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electronics in particular has benefited
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uh the next sector that's benefited
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actually is the automotive sector. Huge
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numbers of huge quantities of automotive
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components are coming out of China as a
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consequence of the development of this
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component infrastructure. Auto assembly
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has burgeoned in China. Some could argue
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that um the center of the auto industry
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has moved from Detroit to
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Shanghai. Um uh all of this I think is a
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consequence of uh WTO.
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Um, where have there been fewer benefits
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or even negative
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benefits? Uh, the answer quickly is the
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countryside of China. The migration has
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depleted the countryside um of many
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working age people. Uh, we talked a
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moment ago about the movie The Last
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Train Home. the couple the protagonists
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in the movie uh they leave their
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children with the grandparents behind in
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Sichuan province as they migrate uh to
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Shenzhen. I also think that Chinese
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agricultures in a bind as a consequence
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of WTO. Uh China's had a number of
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experiments with land reform. The first
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in 78 under Dang Xiaoping was pretty
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successful. Uh the household
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responsibility system they got
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productivity up. Uh, China's not had a
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great starvation since. They're very
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worried about that given the experience
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in the 60s. Today, however, they're
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still struggling with further land
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reform.
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uh there were some initiatives 2002 2008
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to give the peasants control over their
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land but it's they've not really
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succeeded in assembling large enough pla
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plots of land to produce efficiently
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even given the low labor cost. So for
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example two crops in China are uh very
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much at risk. One of those crops I just
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read the article before I came down here
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is the cotton crop. They cannot find
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enough people to harvest the
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cotton. As a consequence, some of that
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cotton is going to stay unh harvested.
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They'll try mechanization, but
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mechanization doesn't work too well
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because the quality of the harvest is
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not nearly as good. Ultimately, they'll
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move to mechanization, but then who
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knows how price competitive uh the crop
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will be. Interestingly, the tomato crops
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in the same situation. This is a very
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delicate fruit. um and uh still uh grown
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on very small plots with hand harvesting
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and the the companies that are uh
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manufacturing the tomato paste which is
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the base ingredient in ketchup and other
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condiments uh aren't doing very well. In
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fact, they're losing money uh end of
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last year and this year again because of
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labor shortages and um raw material
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costs going on going up. And how how is
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China coping with these disruptions in
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the in the rural area?
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What solutions are they putting in
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place? It it's it's really interesting
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because um you have to go back and read
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uh what's called central document number
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one. The last four or five years until
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this year until 2011 central document
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number one focused on rural land reform
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and later rural subsidization market
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adjustment they call it. uh trying to
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take a lot of initiatives to subsidize
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agriculture with certain certain key
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crops and to incentivize people to stay
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on the land. Okay. Still however they've
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not gone quite as far as India as far as
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best I understand India where uh it's
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Indian government policy to keep the
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rural population which is the large
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majority of India it's only 50% in China
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now um to keep the rural population on
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the land by guaranteeing everybody for
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example what is it 100 hours of work a
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month and providing other subsidies to
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make rural life attractive. Uh China's
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not yet done that.
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Um the uh
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interestingly central document number
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one this year has a slightly different
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focus and it's a critical issue for
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China as well. It's called
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water. Uh they were very much worried
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about drought in Shandong province. The
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beginning of the year the rains finally
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came but it was it was pretty bad for a
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while. And you know, if you look at a
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map of China, it turns out the most
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agriculturally intensive areas are in
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that center area of China um uh above
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Jang Su province uh below Beijing, Hub
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so forth. Um and uh they they were going
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without water for a long long time. The
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Yellow River was running dry and water
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will be a perennial problem for China uh
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as well. And of course the water supply
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and the crops are closely related to
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each other. Now coming back to the
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earlier point about the the way the
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manufacturing uh sector especially
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electronic manufacturing is has been one
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of the winners. U how what has this
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meant membership in the WTO? What has it
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meant for the competitiveness of Chinese
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firms? How have they had to transform
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themselves into global producers? And
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what can other companies uh in other
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parts of the world learn from China's
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experience in this respect? Well, I I
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think we got to separate two parts of
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the Chinese uh economy. Um there's the
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foreigninvested assembly
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economy. Again, Foxcon, even think of
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Samsung has huge investment in China. By
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some measures, Samsung's the largest
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manufacturing firm in China.
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Um uh these firms have entered China um
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drawn on a lowcost uh labor labor supply
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uh and a labor supply that at least
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until recently has been uh very very
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reliable um and um uh you know pursued
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lowcost manufacturing for export. Um
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their competitive advantage again is
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cost. The margins are razor thin.
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and they're a bit at risk uh because the
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cost pressures are coming from two
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sides. We're still seeing some
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appreciation of the R&B, although if you
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read the recent columns in the in the
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business press, there's some questions
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as to whether the R&B will continue to
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appreciate near-term. Long-term,
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everyone's confident it will. So, they
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the pressure R&B appreciation plus wage
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increases.
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Okay, the wage
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increases are c are are are driven by
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supply and demand. So let's go back to
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the inflection point we talked about at
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the beginning. One of the interesting
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and I think very significant inflection
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points which we didn't understand until
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about a year ago was rural wages.
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Um this is called um u the uh the the
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Lewis turn the Lewis transition where um
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u uh where
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uh as a economy moves toward
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industrialization
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um uh wages labor supply shrinks first
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in the countryside then in the city and
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wages consequently increase. Well what
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did we see? We saw as early as 2003,
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this is only two years after WTO, wages
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in the deep interior provinces of China
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like Gansu begin to go up dramatically.
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uh agricultural wages uh on the rate of
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10 15% a year sometimes more than that
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wages harvest season offseason the uh
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folks who acquired these data the at the
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Gansu Agricultural University looked at
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it every way came to the conclusion that
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this Lewis turn um occurred uh about in
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2003 again only two years uh after
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WTO now the migrant laborers wages began
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in in the cities began and increasing
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dramatically 2005 2006 a couple of years
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later and so by
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2007 wages were going up 20%.
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And in fact, the labor shortages
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provoked a a a new labor law in China.
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And the 2008 uh labor law, labor
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contract law, LCL,
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um gave workers on in principle, not in
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fact, but in principle, on paper, some
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of the same rights as tenure professors.
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Two, three-year contracts. After that,
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your employment was permanent, discharge
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only for cause, etc., etc. It's quite
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remarkable when you read this document.
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I'm not sure that it's honored more in
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fact in the breach, but uh it's a
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remarkable document to read. But that's
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a response to the labor shortages,
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right? So um 08 was an interruption in
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this a dramatic
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interruption because as you know WTO
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notwithstanding
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exports virtually stopped in some
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industries for lack of letters of
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credit. The government resuscitated the
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economy with a massive stimulus package.
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Don't need to go into details of it but
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it's again another turning point in
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China but some the the the man the
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assembly economy I talked about is being
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hit hard R&B appreciation their
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manufacturing for export and increases
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in labor costs and so parts of that
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economy are at risk. Yeah, I mean that
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that's actually a very good um segue to
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the the point I wanted to raise next
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which is uh clearly China has grown
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dramatically during the past decade
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during after its uh participation in the
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WTO. Yeah, it has uh it it its exports
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were you know 4% of the global economy
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or or so 10 years ago. Now China has
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become the world's biggest exporter. Uh
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how how sustainable do you think is this
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growth? Well, that that follows exactly.
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Um the export economy uh in my judgment
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um is unlikely to continue to grow at
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the same rate. And why is that? U again
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we talked about the cost squeeze on the
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exporters. Um uh and of course economic
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conditions in their principal markets
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whether it's the EU or the US are soft.
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That's a nice term. Uh so as a
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consequence um their ability to sell
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unlimited uh amounts of of relatively
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lowcost goods in these markets is going
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to be crimped somewhat. And there are
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lots of reports now of plants closing
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particularly in Guangong
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province and finally the numbers are
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beginning to show a slowing of exports.
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They didn't for a
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while leading to the inference that it
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was the Chinese domestic economy slowing
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down. I think it actually is a little
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bit or the rate of growth is slowing
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down. Um but um uh it's pretty clear now
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that this export model is not
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sustainable. Now that said um uh the
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Chinese economy has other places to grow
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and here's the irony. The place to grow
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is in the countryside of
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China. And so I think in fact I've
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observed firsthand and I'm writing about
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the development of rural distribution
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and the sudden profusion of rural
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markets in China. Finally at long last
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the traditional marketing system, the
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traditional distribution channels in
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rural China are giving way to much more
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modern systems.
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And as the large firms in China begin to
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penetrate the countryside, which for a
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long time they ignored, that'll give a
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little further headroom to China, but
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not nearly as much headroom as we've
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seen under in the last 10 years. So do
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you think that the growth of the
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domestic market will be uh fast enough
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and deep enough to offset the shrinking
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of the export demand as uh you know
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Europe and US uh you know slow down uh
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and and their consumption slows down? I
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don't know. And here's why. There's yet
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another competing force called
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population. Okay, China's aging.
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uh last year
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2010 the dependency ratio non-working to
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working population reversed um it had
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been going down through 2010 and
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beginning last year it started going up
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um China has made some small
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modifications but hasn't fundamentally
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changed the one child policy even if
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they did it wouldn't make any difference
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for 15 20 years at least
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Um the best projections I see um suggest
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that China is going to have an upside
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down population pyramid very very
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quickly. And uh I sometimes describe it
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as as a pagota
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uh looking very much like like Japan
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today.
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uh uh the EU is not going to suffer this
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to the same extent the US provided we
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still have some immigration is not going
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to suffer it at all and what happens
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when the population ages there's a
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reluctance to spend money at least on
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consumer
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goods and uh we see this and actually in
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marketing surveys in China that uh many
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people though they have money are are
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reluctant to spend so the question is
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what steps can be taken to unleash the
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the buying power of of of domestic
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consumers. Now again, there's a group in
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the countryside, very large group, not
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the wealthiest in China, but not poor,
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um, who have untapped spending power and
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simply haven't had access to goods,
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which they'll now have. But how much
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more spending is going to take place in
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the urban populations uh, as they think
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about getting older, requiring social
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security, support if they can get it,
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medical services, etc. I don't know. I
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think that's the big question mark for
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China. So if you look to the next 10
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years by
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uh
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2021, what other inflection points do
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you see coming down the
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pike? That's an interesting question. Um
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uh the
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the there are a couple of inflection
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points. One's next year the government
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will change.
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We have no idea what the policies of
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Xiinping are going to be. We we simply
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don't know. He's been very careful. Will
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he be another who Hu Jun Tao? Will he be
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another Jew? Jurong J. Nobody
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knows. Um that's probably the most
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fundamental inflection point coming up
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soon. uh it will take a few years to
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know what direction China uh uh China
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takes. I think continuation of the
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present policies
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will alone or slow or cap
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economic growth a bit because
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um under Huenta
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um there's been a resurgence of the
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wealth and to some extent the power of
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the state enterprises uh in China um
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fewer are employed by the state the s so
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s so s so s so s so s so s so s so s so
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s so ses
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um uh are responsible for you know less
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and less of overall output in GDP but
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still their centrality in the economy uh
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has gone up and the question is whether
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there's going to be a second and
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vigorous wave of privatization in China
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turning toward a more capitalist system.
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We don't know the answer to this
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question and I think that's a very very
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fundamental question. Um a second
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inflection point will would will occur
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if under lower growth
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scenario different provinces go in
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different
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ways. Um you've maybe read about you've
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perhaps read about uh uh
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Bilai who is the party secretary of
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Chongqing.
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um uh he's advocating uh a
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very domestic centric uh set of
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policies. We should produce for the
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people's needs here in China. Okay.
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There's also a little bit of Mauism
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associated uh with Mr. Bo uh which
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people have seen in Time magazine and
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other places. Uh so his policies are
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very inward-looking. Take care of the
00:20:07
people. If you go down to Guangdong
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um which has been the export engine of
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China um you'll see a different
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scenario. The government there I sat at
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an economic forum actually keynoted
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economic forum Guangdong uh in June the
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conversation was entirely about building
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and rebuilding our export industry.
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So the second turning point would be
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this kind of internal conversation if
00:20:34
you will between uh a policy of focusing
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on the home market and f focusing on the
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needs of the people versus maintaining
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the export machine and um uh how that
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would play out politically I have no
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idea but clearly uh something like that
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uh is is coming along. Um third
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inflection point um
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innovation. China has a set of policies
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uh designed to promote innovation.
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Whether they'll have the effect, no one
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knows yet. Among other policies, um just
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like their targets for GDP growth, their
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targets for patents. The rate of
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patenting in China far exceeds patenting
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in the US. Um, and uh, although many
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many of the patents are so-called
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service patents of short duration, uh,
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many of them are not renewed because
00:21:30
they're of no economic value. The number
00:21:32
of patents of economic value is hard to
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determine, but in any case, there is a
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commitment to patenting and political
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advancement depends on GDP, but for some
00:21:41
officials, it also depends on patenting
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and patenting. There's also a policy of
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indigenous
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innovation and it's been around for a
00:21:50
while and the government asserts it and
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then you know last June or so said well
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we withdraw part of it but basically in
00:21:58
government purchasing the policy is or
00:22:01
was to favor locally developed products
00:22:06
products developed not necessarily by
00:22:07
Chinese-owned companies but by reg
00:22:12
Chinese registered business entities
00:22:14
they could be foreignowned
00:22:16
And of course um many of the MNC's other
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western businesses have objected to this
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exactly where the policy stands a little
00:22:25
unclear. Uh as always the rule in China
00:22:28
is it's going to vary by province. So it
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it's hard to tell but that that that
00:22:33
innovation inflection point if it works
00:22:36
as anticipated could counteract some of
00:22:38
the other forces I'm describing. Right.
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uh uh since we were talking a little
00:22:43
earlier about uh you know the the export
00:22:46
market and one there's also of course
00:22:48
this financial aspect to it. Uh China
00:22:51
has been trying so hard to globalize the
00:22:55
R&B and I was wondering uh how you see
00:22:59
that playing out over the next 10 years
00:23:01
or so. The
00:23:04
R&B that's an interesting question. Um
00:23:08
uh f first I will confess even on camera
00:23:11
that this is not my expertise. Uh having
00:23:15
said that
00:23:17
um I
00:23:20
think they're in a bit of a bind and
00:23:24
here's why. By globalizing the R&B you
00:23:27
mean rendering the R&B convertible on
00:23:30
the capital side, capital accounts and
00:23:32
that would allow bond markets to open up
00:23:34
so on and so forth. If you don't have
00:23:36
convertability, it's very hard to get
00:23:37
global investors in there to purchase
00:23:39
bonds. Precisely. Okay, here's the rub.
00:23:43
Look at M2 in China. The money supply,
00:23:46
it's like a rocket. It's going up a lot
00:23:49
faster than their
00:23:50
GDP. You know, you're looking at numbers
00:23:53
in the vicinity of 20% a
00:23:55
year. And the question
00:23:57
is, what's the source of it? And can
00:24:00
they reverse this at the source?
00:24:05
And um this and and the source
00:24:10
ironically in my
00:24:12
judgment lies um in their currency
00:24:19
policy. Why is that? Uh when the Chinese
00:24:24
government when I take to the Chinese
00:24:27
government, the people's bank of China a
00:24:29
dollar, I'm an investor. Okay, I need
00:24:31
R&B. Okay, they give me the R&B,
00:24:33
although in decreasing amounts. I think
00:24:35
we're at about 6.4 right now, something
00:24:37
like that. Um, they hold on to the
00:24:40
dollar, they don't sell that dollar
00:24:43
because they want to keep the country
00:24:45
export
00:24:47
competitive. So rather than selling the
00:24:49
dollar,
00:24:51
um, uh, they, uh, they they hold the
00:24:55
dollar and the central bank reimbures
00:24:58
the commercial bank where I exchange the
00:24:59
money. um effectively not with fresh
00:25:04
RMBB but rather with what are called
00:25:07
sterilization bills long-term low
00:25:11
interest notes.
00:25:13
Okay? And the banks are required to hold
00:25:16
them in their reserves. That's one of
00:25:17
the reasons the reserves are so high.
00:25:21
And um the consequence of this is that
00:25:25
um uh on the one hand you've got all
00:25:28
this currency around. On the other hand
00:25:31
uh banks are finding it harder and
00:25:33
harder to loan money because the reserve
00:25:35
requirements go up. That's a that's a a
00:25:37
check on inflation. If those bills do
00:25:39
somehow circulate, I'm not confident
00:25:41
that they don't circulate. That's a
00:25:43
double negative. I really don't
00:25:44
understand the intricacies of the
00:25:46
system. I'm not sure anyone here does.
00:25:48
Right. Uh but if they circulate, they
00:25:51
create inflation because there's so much
00:25:54
money around. Um if they don't
00:25:56
circulate, they crimp they crimp loans,
00:25:59
they crimp industry. And so China's in a
00:26:03
bit of a bind because imagine imagine
00:26:07
what would happen if suddenly the the
00:26:11
R&B were fully
00:26:13
convertible. Okay? What would happen is
00:26:16
people are going to wake up and see what
00:26:17
we've seen anyway but aren't fully
00:26:19
taking into account and that is prices
00:26:22
are very high in China. I have a slide
00:26:24
I'm going to use tomorrow in class on
00:26:26
food prices in
00:26:27
China. Supermarket prices in China. Sure
00:26:30
rice is cheap, cabbage is cheap compared
00:26:32
to the US. Uh but if you look at the
00:26:34
price of pork, not a lot different.
00:26:37
actually milk not a lot
00:26:40
different and Chinese incomes at least
00:26:44
by the official statistics are a lot
00:26:45
lower than ours. So there there are
00:26:48
there there are a lot of um there'll be
00:26:50
a lot of unanticipated consequences of
00:26:52
freeing up the R&B and yet there's no
00:26:55
alternative to it because basically the
00:26:58
people of China are paying the price of
00:27:02
uh an RMB that's uh uh pegged uh you
00:27:06
know at a fairly low level uh at this
00:27:09
point. So let let me ask with end with
00:27:12
one final question. Hypothetically,
00:27:15
let's assume that you were invited by
00:27:16
the Chinese government to give them some
00:27:19
advice on how they should navigate the
00:27:21
next 10 years uh of uh participation in
00:27:25
the WTO so as to maximize the benefit to
00:27:28
the Chinese economy and the world
00:27:30
economy. Uh what would you what advice
00:27:33
could you give them? Oh, it would be
00:27:35
unequivocal. I would they wouldn't
00:27:37
listen to it, but it would be
00:27:38
unequivocal. I mean that is like if if
00:27:41
if you know the the people of China have
00:27:44
as everyone has aspiration to become
00:27:47
middle class right and um uh uh and yet
00:27:52
some sense the uh the the the business
00:27:56
model China's been using under WTO has
00:27:59
run its course. Costs have gone up.
00:28:02
Labor's labor is tight. Population's
00:28:06
aging. Okay.
00:28:08
What's the solution to the problem?
00:28:10
Well, um, the solution doesn't lie in
00:28:13
pouring more concrete, which is what
00:28:15
they did in response to 2008. The fixed
00:28:18
asset investment just blew through the
00:28:20
ceiling. No, the solution lies in the
00:28:23
quality of your people.
00:28:26
And as a consequence to move up the
00:28:30
value chain
00:28:32
um you've got
00:28:34
to upgrade the skills of your folks
00:28:37
which means a huge investment in
00:28:41
people. So I'd stimulate the demand
00:28:46
side by trying to provide modest social
00:28:49
safety nets where none now exist. It's
00:28:51
very important so that the aging
00:28:53
population, the aging consumer class
00:28:56
willing to spend a little more, but at
00:28:58
the same time, given that there's going
00:29:00
to be a shortage of people, that you're
00:29:01
going to be substituting sophisticated
00:29:03
equipment for people. Um, you're going
00:29:06
to have to upgrade the skills of people.
00:29:09
Um, probably at all levels, including
00:29:12
managerial. Um, so one recommendation is
00:29:16
they send their most promising people
00:29:17
here to
00:29:18
Wharton. Okay. I know seriously so they
00:29:22
learn the skills that are needed to run
00:29:24
very complex very sophisticated
00:29:26
enterprises u but more generally that
00:29:30
they try to take some of the folks whose
00:29:32
experience is in manual labor and train
00:29:36
them to be sophisticated technicians so
00:29:38
that China is able to continue to grow
00:29:42
relying on higher value added industries
00:29:45
and sheds the lower value added
00:29:46
industries again like the needle trades
00:29:48
clothing stuff like that. So that that
00:29:50
that would be the recommendation.
00:29:53
Marshall, thank you so much for joining
00:29:55
us today. As always, it's a pleasure to
00:29:56
be here. Thank you very much.
00:30:04
[Music]
