Last week I spent in Brazil, where I was honored to meet someone I admire very much, former Brazilian President FH Cardoso, along with a large group of Brazilian investors, politicians, and academics, including several old friends. At some point I will write about some of the things I learned there, but I am still a little too tired and jet-lagged to collect my thoughts. As soon as I returned to Beijing I had to go spend two days in Wuhan, a city I had never visited before but a really interesting place with an absolutely wild cultural scene, not all of whose characteristics are totally legal, and so because of all this travelling it has been eight days since I last posted anything here. My apologies.
Since I am still a little addled and way behind on work I don’t have much to write except a series of miscellaneous notes. The first is extremely anecdotal, admittedly, but also worrisome and more than a little humorous. In an entry two weeks ago, as evidence of some of the dangers of the current loan boom, I mentioned an article that my friend Dan Rosen had sent me. It discussed a statement made by Lin Zuoming, the General Manager of AVIC, the largest single borrower in the current lending spree, who said that now that he had raised $35 billion, his biggest single worry was “how to allocate the borrowings to increase returns.” Dan found it a little worrying (as did I) that anyone could engage in such massive borrowing without a clear sense of what he planned to do with the money.
Thursday Dan sent another article that partially helps clear up the mystery. OTC:AVIC has recently decided to place RMB240 million with a private equity fund to invest “in technological renovation and production capacity expansion of the special spherical plain bearings project,” which I think are ball bearings.
I don’t doubt that ball bearings are a profitable business, but it seems to me a bit of a stretch for an aircraft manufacturer (although I suppose airplanes use ball bearings) to make a large investment in a ball-bearing producer. In the 1970s Americans learned the hard way how dangerous it was to allow CEOs free rein to exercise their natural preference for expanding their companies into a wide range of unrelated businesses – all of which was made easy and almost inevitable by access to seemingly “free” capital. We spent a very difficult 1980s watching the famous conglomerates created in the 1960s and 1970s brutally torn apart so as to eliminate their huge inefficiencies.
Give CEOs anywhere unlimited access to very cheap funding, and pressure them to take as much of it as they can, and it would be surprising if they didn’t manage to convince themselves of the viability of quite a few projects that, under different funding circumstances, they would have avoided. By the way, in this context I should mention a very interesting April 2009 paper, produced for the HKMA by Giovanni Ferri and Li-Gang Liu, which argues that the rapidly rising profitability of SOEs may be a mirage.
We are interested in in investigating whether the profits of SOEs would still be as large as they claim if they were to pay a market interest rate. Using a representative sample of corporate China, we find the costs of financing for SOEs are significantly lower than for other companies after controlling for some fundamental factors for profitability and individual firm characteristics. In addition our estimates show that if SOEs were to pay market interest rate, their existing profits would be entirely wiped out.
In my reading it seemed to me that the authors only compared SOE funding costs to that of other Chinese corporates, and did not take into account the possibility (very likely) that overall interest rates are much lower than they would normally be because of regulatory controls. Had they done so, they might have found that SOEs are actually value destroyers, made profitable only by the fact that the income of savers has been “appropriated” and converted into subsidies via very low interest rates. Besides what this means for value creation in the economy, this is important because it also affects consumption levels (remember that in China low deposit rates are associated with higher savings) and trade policy. In another entry I will discuss low financing costs as being as much a trade-related policy as tariffs and currency levels.
At any rate as the AVIC anecdote suggests I suspect that at least part of the current fiscal stimulus in China will end up creating more corporate monsters who will work hard to keep productivity growth in the future low. This is all the more likely since it seems to me that quite a few Chinese policymakers (and much of the general public) are a little too comfortable with the idea of national champions and other forms of corporate gigantism, even though the evidence for their social and economic value is pretty limited.
This of course is not in and of itself an argument against a large stimulus program, since it would be easy to counter that even wasteful spending is acceptable in a crisis (I don’t necessarily agree, but many wise people have said so), but of course I am very worried that China is making it more difficult to deal with its own transition. At any rate I am not sure that wasteful spending to drive this year’s growth rate up from 6% to 8% is such a great idea if it causes future growth rates to drag significantly. This will not be a quick crisis which we can put behind us next year.
I discuss all of this in an article in Wednesday’s Financial Times, titled “Asia needs to ditch its growth model,” with which many of whose arguments regular readers will be very familiar. My basic argument, of course, is that policies that constrained domestic consumption growth while boosting production implicitly required someone (the US) to run large trade deficits, and with US savings on the rise, those days are over, at least over the next decade. As if to reinforce those claims, last week there was a very interesting article in the New York Times about US savings, which starts out with “The economic downturn is forcing a return to a culture of thrift that many economists say could last well beyond the inevitable recovery.”
The piece argues that it is unlikely that this time, unlike after previous short-term crises, Americans will return to high levels of consumption once the economy stabilizes. Higher savings rates may persist for long after the economy finally turns around.
To continue on trade-related issues, I thought I would refer to an article in last week’s Financial Times with the ominous title “US lawmakers to revive China tariff bill.” According to the article:
A group of Republican and Democratic lawmakers will on Wednesday revive a bill that threatens to raise tariffs on Chinese goods to punish the country for what they call “currency manipulation”. Highlighting the protectionist sentiment within Congress, the bill would let companies apply for tariffs on imports from countries deemed to be deliberately undervaluing their currencies to be more competitive. China is its main target.
“By illegally subsidising its exports through the undervaluation of its currency by 30 per cent or more, China distorts the gains from trade, creates barriers to free and fair trade, harms US industries and has destroyed millions of US jobs,” those sponsoring the bill said in a statement.
Their move comes as countries across the world consider protectionist trade rules in the face of recession. Measures such as anti-dumping investigations rose 18.8 per cent in the first quarter of this year against the same period in 2008, according to research by Chad Bown at the Brookings Institution, with China’s exporters the target in two thirds of those cases.
As I have said many times before, I am very pessimistic about our ability to prevent a sharp rise in trade friction and an equally sharp contraction in international trade. The OECD website is currently running an article called “World trade set to fall 13 percent, OECD urges governments to avoid protectionism” in which they claim that world trade will drop 13% from 2008 to 2009. Not surprisingly China is worried, and today’s People’s Daily discusses one of the now-familiar response:
Chinese Premier Wen Jiabao announced Wednesday that China will shortly send another buying mission to the European Union (NYSEARCA:EU) to increase imports from Europe. The Chinese trade promotion mission sent to the EU immediately after Wen’s European tour in January had produced positive results, Wen told reporters at the end of the 11th summit between China and the European Union (EU).
“China is ready to work with the EU to further promote mutual investments, enhance cooperation in small- and medium-sized enterprises, trade facilitation, science and technology, transportation and post, in an attempt to fight all forms of trade and investment protectionism,” said Wen. He expressed the hope that the EU will loosen control over export restrictions on high-tech products and nurture new growth potential in economic and trade cooperation in order to further promote China-EU trade.
In spite of the good-will generated by these buying missions (and I am not sure how much good will this really creates — my European corporate friends are extremely cynical about these missions), I don’t think there are a lot of warm and fuzzy feelings about trade anywhere in the world just now. The various claims by interested parties don’t seem to be making the prospects very bright.
To show how confused the debate has become, and how unlikely we are to see a good resolution, I recently participated in a panel with a Chinese economist from a leading local investment bank who gave an impassioned argument against financial protectionism in the US. Among her claims were that China is totally open to foreign investment whereas the US and the West are almost wholly closed to Chinese investment which, she seemed to think, was extremely unfair. This is a claim I have heard so often in China that I am worried that it has become entrenched in local thinking.
The economist argued as evidence of this unfairness that that any foreigner could start a joint venture in China, or engage in any form of FDI, whereas the opposite was almost impossible. But this is mistaken on many counts. First of all, the restrictions on Chinese investments abroad have not been on FDI or other related start-ups and joint ventures. They have occurred when Chinese companies tried to buy large, existing companies that were considered, rightly or wrongly (and more often wrongly, I think), strategic assets.
But, and contrary to what the economist claimed, foreign purchases of equivalent Chinese assets are far more restricted. Almost every large company in China that a foreigner has tried to purchase has been prevented on the grounds of strategic interest, even some amazingly bizarre recent cases, and generally speaking most foreign companies don’t even try to buy large companies in China because everyone expects that transaction automatically to be turned down by the regulators. China, for example, would have never even considered anything similar to the purchase of IBM by Lenovo, and so no foreign company wonders about the possibility.
On the other hand, it is true that foreigners can fairly easily start new companies, enter into joint ventures in China (well, fairly easily – a lot of industries are off limits), and otherwise engage in FDI, but there are likewise almost no restrictions for Chinese investors in the US or elsewhere in the West to do the same. Any Chinese company that wants to start a company in the US from scratch can do so, with very few restrictions that would not apply to US or other foreign investors.
The point is that many Chinese sincerely believe that the restrictions facing their expansion abroad are much more onerous and stringent than the restrictions facing foreigners in China. Foreigners, of course, sincerely believe the opposite. Both sides feel aggrieved. Regardless of who may be right, the fact is that these very sincere beliefs make accommodation difficult.