I had a very interesting conversation with a reader about an article I wrote about China. He argued that there is something very important and intangible economists cannot measure — the will of people. That will becomes even stronger when the country’s past is ridden with political and economic misery. Think of Germany and Japan after World War II, their economies were in shambles but human capital and ingenuity played a lot larger role in their recovery than the traditional capital. In other words economic models at the time would have predicted that those economies would not recover as fast and as well as they did, as they would not have accounted for human factor, the raw (and very selfish) drive to succeed.

The reader was making the argument that because of its poverty-stricken past, like Germany and Japan did after WW2, the Chinese people’s ingenuity will put their economy on a tremendous growth trajectory. I thought it was a very interesting observation, though I never really made an argument that China is going to fail and go back to pre 80s or 90s era. My argument was that all good things need time to rest, that is why economies have normal cyclicality (periods of expansion are followed by recessions). Chinese growth was very high for a very long time, it needs a good rest which it doesn’t get because its government is afraid of civil unrest and thus is spending money at a very fast pace.

Misery alone is not enough. Japan and Germany recovered and blossomed because those were capitalistic societies, in fact their success is a triumph of capitalism. China is toying with communism (socialism) and capitalism at the same time. Unfortunately, at the time of crisis if a choice is given government will chose the path of lower resistance – the communism (socialism). (Just think of what our government is doing today.) Although the harder, the right, and more painful (at least in the short run) choice is creative destruction — capitalism.

Russia is a good example, the same Japan/Germany after WW2 argument could have been made about Russia in early 1990s. It had a very educated population, which saw plenty of misery. For a while Russia was going the right direction, but the crisis of the late 1990s shifted the country back from democracy and capitalism toward a more command and control economy. This conversation made me realize that Chinese success in the future, past the short run, will depend on the market system it chooses. Capitalism will let the human ingenuity fester where communism just going to crash it.

In investing it is important to think unconventionally, to consider not obvious risks but the ones that are hiding around the corner. For many investors it is a foregone conclusion that China will consume more stuff (energy, materials, industrial goods) in the future, thus many argue that one should buy what China needs – the stuff. But this investment thesis will only workout if China sticks with capitalism, if the current crisis will not push it towards the road of the least resistance - the communism. Thus let me issue this warning: If I were to follow the “buy what China needs” investment I’d watch political developments over next couple of years in China very closely.


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