Development Bank Research Bulletin

What US stocks China may want to buy with its foreign reserve?

China has decided to diversify away from US treasury bonds, and invest up to $200 billion of its huge foreign reserve in equities in order to boost the return on its foreign reserve holdings.

Making financial profits is certainly one of the major objectives of the foreign reserve managers, but it is also expected that Chinese government may want to create benefits for its own economy (and Chinese employment) as much as possible. In short, they don’t want too much net capital outflow. In any case, a poor country is certainly in greater need of capital. But how can Chinese achieve these goals?

One possible way is to link the portfolio allocation decision to US corporations investment decision in China. Chinese government may want to invest more in US multinationals that promise to invest more in China-based projects.

According to the Commerce Department’s “2007 Investment Climate Statement”, these large US corporations active in China include (ranking by their Chinese asset size):

Motorola, General Motors, Wal-Mart, General Electric, Kodak, DaimlerChrysler, Coca-Cola, Exxon Mobil, Ford, Intel, Anheuser-Busch, DuPont, Alcoa, United Technologies, IBM, Cummins,  and Microsoft.

In any case, these are large and liquid US stocks and are thus perfect candidates for foreign reserve investments.

Moreover, strategically speaking, some of them can be very valuable for Chinese if the Chinese can acquire significant block of shares and have a say in the management.

Wal-Mart for example can give Chinese a perfect retail distribution channel in the US for Chinese products. General Motors, which has run into financial troubles, may help Chinese build up its domestic car industry, in exchange for financial injection from the Chinese. Motorola, IBM, and Microsoft can help Chinese upgrade their information technology.

It is predictable that there will be a huge political backlash in the US when the Chinese acquire significant share block in any one of these corporations.  But who are you going to blame? If Americans save less than invest, and America has to let foreigners in to bring in the money.

Return to Capital is not low in China

There are two famous myths about China.

The first one is that the savings rate is high because ordinary Chinese worry about the lack of safety net. This myth has been busted because evidence has shown that Chinese household savings rate is actually lower than the Indian one. The overall saving rate is high because businesses heavily save their self-generated profit for re-investment. For private business, the reason is the lack of access to other forms of external finance. For state-owned enterprises, managers always prefer re-investing the profits to paying dividends to the government. Therefore, the right solution is: (a) to reform the financial sector and improve the access to finance for private sector businesses; (b) force state-owned enterprises to pay dividends! Building a safety certainly will help, but only at the margin.

The second famous myth is that return to capital is very low in China, and that the current high investment rate is a sign of money being wasted. A NBER working paper "The return to capital in China", written by three prominent Chinese economists, however shows that the return to capital in China has been remained flat at roughly 20% since 1998, which is not low compared to the rest of the world. Olivier Blanchard also provides a nice discussion (PDF file) of of the results.

As a matter of fact, the myth about the high investment rate per se has also been overturned. Goldman Sachs economist Hong Liang show that the investment rate is between 36%-40%, and the incremental capital-output ratio (ICOR) is about 3.1 in recent years. These are two very reasonable numbers for a rapidly growing economy. In at least the export-oriented sectors in China, improvement in productivity still remains that greatest driver of growth.

I have long been the subscriber of the view that China is still a very poor country; the gap to the productivity frontier is still so wide that the main decision to make is still how much to invest rather than where to invest. Chinese are starting to worry about investment efficiency, but at this moment it is still of second order importance. The nation’s production is still so inefficient that there are numerous easy opportunities waiting for entrepreneurs to capitalize on. In order for this to happen, the government should remove the planning-economy-era regulations that create the inefficiency, and protect the property rights of entrepreneurs. These reforms will create prosperity much more than will any scientific breakthrough.

Newspapers like to repeat the same punch line “the money is wasted in building roads that lead to nowhere” when describing the government investment in infrastructure in China. But people familiar with the geography of China would find it difficult to find any such “roads that lead to nowhere.” Even if an idiot randomly draw a line on the map in the eastern seaboard and build a toll road; in five years the road capacity will be full. That’s exactly why there are so many corruptions in such infrastructure projects: high returns are guaranteed so long as you can get the license to build the toll roads that almost always lead to somewhere. The new Chinese saying: money follows the roads.

The Return to Capital in China (download pdf file)
Chong-En Bai, Chang-Tai Hsieh, and Yingyi Qian
NBER Working Paper No. 12755
December 2006
ABSTRACT: China's investment rate is one of the highest in the world, which naturally leads one to suspect that the return to capital in China must be quite low. Using the data from China's national accounts, we estimate the rate of return to capital in China. We find that the aggregate rate of return to capital averaged 25% during 1978-1993, fell during 1993-1998, and has become flat at roughly 20% since 1998. This evidence suggests that the  aggregate return to capital in China does not appear to be significantly lower than the return to capital in the rest of the world. We also find that the standard deviation of the rate of return to capital across Chinese provinces has fallen since 1978.

China's lobbying industry spends $2.5 billion annually

According to an article "The harder they fall" in the Economist (Sep 30, 2006):

"More than 5,000 localities from provincial down to county level have opened offices in Beijing in recnet years, spending some $2.5 billion annually on lobbying, according to China's media..."

A huge industry!

Chinese private sector firms are twice more productive than state-owned firms

An OECD report “Fast-falling barriers and growing concentration” (pdf file) shows that Chinese private firms are twice more productive than state-owned firms.

This seems to be a very clear and common sense fact that shouldn’t need to be studied in the first place, but there are actually many people who still believe that state-owned firms, with proper restructuring and introduction of modern management expertise, can turn around, and do much better than private sector firms.

The favorite example they always cite is the higher profitability of giant state-owned firms listed in Hong Kong, particularly those in the energy and telecommunication sector, compared to low profit margin private sector firms in the consumer electronic industry. They are comparing apples with organs though. Even an idiot can run a very profitable state-owned firm in the energy sector: a monopoly can charge whatever price it wants and realizes any level of profitability it wants . Consumers are losing out and paying the bill though.

This OECD report sends a hard blow to people who still believe in the viability of state-owned firms. The report uses data from the government statistics bureau: if anything, it should have underestimated the productivity of private sector firms, for they always understate their revenue for tax purpose.

State-owned firms, go kill yourself, you are wasting everyone’s resources.

Indian households save more than Chinese!

According to a new report by McKinsey “Putting China's capital to work”, Chinese households save 23.8% of their disposable income, not particularly high compared to the saving rates of Asian tigers in their high growth period.

Indian households save 31.9% of their income, a ratio that is much higher than Chinese. The current saving rate of French is 16.6%

Chinese = high saving rate? Myth busted!

The report points out that the high total saving rate of China is mostly the result of higher corporate saving rate, which stands at twice world average. The report however also cautions readers that the higher household saving rate of Indians could be the result of small and micro businesses reporting themselves as households.

Nevertheless, the Chinese saving rate could be overestimated too, as Chinese disposable income, the denominator of the ratio,  is severely under-reported because of the huge underground economy.

Note that saving rate of an average Chinese household could be much lower than the headline number. In 2003, 1.86% of the wealthiest Chinese households control 60% of the total stock of liquid financial assets in China, and they certainly have much higher saving rate than poor people. A McKinsey survey indeed shows that the lowest income quintile of Chinese households save only 20% of their income.

A new political economy: China grew at 10.9% in 1H06

China grew at 10.9% in the first half of 2006, and 11.3% in the 2Q, surprising almost all major investment banks.

"Maybe this is a new economy" said Stephen Green, China economist for Standard Chartered Bank, "Maybe China can grow fast without inflation"

I am not sure whether China can grow fast without inflation, but I am expecting the fast growth this year and I am not surprised at all.

As I wrote in the Bulletin back in April, things are changing in China. It may not be a "new economy", but it is certainly a "new political economy!"

The Communist Party's 17th national convention is upcoming in the second half of 2007, and thus major personnel promotion decisions will be made in the first half of 2007. Every provinical boss is working hard to secure political capital before the event, and GDP is the key political capital. In today's new political landscape where strongman politics is phasing out, GDP becomes more and more important a bargaining stake for provincial bosses.

So don't expect a slowdown in the second half. The economy is going to operate at full speed.

As I wrote in that article:

"Year 2006, however, is the last year of the 2002-2006 political cycle, and based on past experience, should grow at the lowest speed. The economy however grew at the highest speed in ten years. Something must have changed. One speculation is that the incentive structure has changed. In the past, provincial heads worked hard in the first and second year of the cycle to impress their national boss. Now they work hard in the last year to pro-actively build up political capital for their future career which will be decided in the 2007 national meeting of the Communist Party, and the best political capital in China is GDP, GDP, GDP!  At national level, central government wants to slow down the investment boom, but provincial bosses have made up their own minds. "

Goldman Sachs: China makes largest progress in energy efficiency than other developing countries

Goldman Sachs publishes a note "Improving energy intensity across the BRICs"  (pdf file). There are several interesting take-away points:

(1) China’s energy use per unit of output in industry fell by 56% between 1994 and 2003, which is the largest energy-efficiency improvement progress in developing world. In the same period, India only achieves reduction of 30%, and Brazil almost makes no progress.

Why is everyone blaming China for using too much energy?! China uses more energy simply the population is larger and the economy is still in the early stage of industrialization, and as such a large economy, China is already making much better progress than others.

(2) Russia remains the most energy-intensive countries in the world, The country’s energy intensity is close to three times that of US.

Not surprising, considering that the government is subsidizing energy (for Russian residents) to such an extend that electricity is almost free. By the way, Venezuela always consumes a lot of gasoline, because the price is heavily subsidized. I always say that letting market to determine the price is the best weapon against energy waste.

(3) In China, non-industrial sector is twice more energy-intensive than industry.

I have no idea why!

(4) Projection results show that BRICs (except Russia) will consume much less energy per capita than the current level in more developed economies (U.S., Japan, etc) when  they reach the same income level of developed economies.

I.e., both now and in the future, Americans will remain the heaviest user of energy, even on per capita term.  Why do Americans still point fingers at developing countries and keep on blaming China for exhausting the energy resources of the planet?

Implication for the relationship between growth and environment : as a country gets richer, it will use less energy (because industry becomes more productive and structural shift to service sector will also save energy). The best weapon against pollution is economic growth, not to turn Africa into a zoo.

Year-half assessment of investment banks’ forecast accuracy on China’s GDP growth

In a previous Bulletin article written back in February, I summarized several major investment banks’ forecast of China’s 2006GDP growth rate.

Now it is time to assess the accuracy of these forecasts after six months have passed.

In the first half of 2006, China was growing at unprecedented and unexpected pace, at 10.9% on year-to-year basis. Only Credit Suisse’s forecast of 10.1% can be said to be in line with the actual outcome. CSFB’s China economist Dong Tao is doing well

Thus most investment banks are revising their forecast up ward:  Deutsche from 9% to 9.9%, Citigroup from 8.7% to 9.3%, and Morgan Stanley from 7.8% to 9.5%. The consensus now is 9.7% (based on data from Consensus Economics).  (Deutsche Bank again is following the herd in setting their forecast! Can they be a little bit braver?)

Morgan Stanley, after two years of very poor performance in forecasting China’s GDP growth finally makes a large upward revision of the number. They have been voicing their worry about China slowdown for a long time, and have been the most pessimistic about growth rate of India and China back in 2004, and 2005.

Stephen Roach in his commentary (10/21/2005) in MS’s Global Economic Forum supplied some explanations on why they were wrong on the "China slowdown", and why they still believed that slowdown in American consumption (as a result of oil shock and low saving rate) may “ultimately” causes a China slowdown. Well, he is wrong again.... I am expecting a follow-up execuse from him

I think China's potential slowdown in the future is more likley to be caused by domestic problem instead of external factors. China is not exporting many durable goods to the U.S., and I think Americans even in recessions have to buy clothes and have to give Christmas gifts to children. I don’t deny that China is dependent on U.S. market, but not in the same way as Japanese do (they export cars, the demand of which is more cyclical)

McKinsey says financial sector reform could raise Chinese GDP by 17% a year

A study recently published in May by the McKinsey Global Institute, titled "Putting China's Capital to Work: The Value of Financial System Reform", has found that financial sector reforms in China, if properly executed, would raise gross domestic product by an astounding 17 per cent, or $321bn.

According to the report: better capital allocation would raise GDP by $259bn, while improving the efficiency of the banking system, switching from paper-based to electronic payments, and diversifying the mix of funding vehicles for corporations would raise GDP by $62bn annually.

Another report by McKinsey points out that Chinese domestic banks are more fragile then we thought, when facing foreign competition likely incoming in 2007.

We usually think that foreign banks cannot compete with Chinese local banks in retail banking, because it is prohibitively expensive for any foreign banks to attempt to replicate a nationwide branch network.  McKinsey report however identify an opportunity: just 2 per cent of local banks’ customers account for half of total household deposits and the bulk of banking profits in retail banking. 

This means that it is actually not that difficult for foreign banks to poach away these small number of "high net-worth individuals"  without setting up a huge branch network. These wealthy customers are more likely to have private transport vehicles and shouldn’t care that much about the location of the bank branches, so long as they are located in the posh financial districts.

Bad news for gigantic Chinese local banks though. The report warns that "If even a small number of customers from this group shift to the foreign competitors, existing banks could face a liquidity crisis"

Hat tip: Financial Time: Ready to compete in global markets

Inefficient banking sector in China is actually an optimal way of taxation

It is well perceived that China's state-monopoly banking sector (with the help of capital control) is a powerful tool in channelling private sector wealth into loss-making state-owned enterprises and numerous white-elephants public infrastructure projects.

A paper written by several Chinese economists however argues that such a mechanism is actually optimal. The idea is as follows.

In developing countries, it is usually very difficult for the government to collect taxes (everyone hides their income), and official taxation is usually very inefficient (it creates a lot of distortion in the economy and a disproportionate burden on hard-working and smart people). Formal taxation thus becomes very costly and creates a lot of dead-weight costs.

But the government needs money and by whatever means the government will try to extract revenue from the private sector. Conditional on the "grabbing hand" nature of the government, an “implicit taxation” by channeling private sector wealth into low-return public projects, through the monopoly banking sector, becomes an optimal and efficient solution:  it is efficient because (1) the cost of “tax “collection is low (you can avoid it only if you completely go underground) (2) the “taxation” is relatively fair and less distorting (it is proportionate to your existing wealth).

Certainly it is even better if the government does not try to extort the private sector in the first place. But if the government does do it, it is better that it does it through the banking sector. At least you don’t need to pay the robber to rob you, and at least hard-working people don’t have higher chance of being robbed.

When a gun is pointed at you, it makes no sense to fight. Take my money but don't hurt me.

Financial Repression and Optimal Taxation (pdf file)

Chong-en Bai, David D. Li, Yingyi Qian, Yijiang Wang

Financial repression entails an implicit taxation on savings. When effective income-tax rates are very uneven, as common in developing countries, raising some government revenue through mild financial repression can be more efficient than collecting income tax only.

China offers to build 1 M low-cost houses.....for Filipinos though

I was at first very excited when reading the title of the news: “China offers to build 1 M low-cost houses”. Chinese government is starting to fulfill its promise to help low-income people! I thought.

As I read on, however, to my disppointment, I discovered that the houses will be built in Filipinos in Philippines.

I am not saying that China should not share the responsibility in helping poor countries, but come on, there are more people back home in China who are in greater need of housing, and China after all is not a rich country.

Shouldn’t China solve the domestic problems first? Shouldn’t China treat its own citizens well first?

But then I remember something:

Oil reserve, offshore Philippines in China sea!

Then it could be profitable deal.

Private Sector Development is good for the environment: new data from World Bank’s China office

Private sector and privatization is always blamed for the degradation of the environment. Some self-proclaimed “environmentalists” always insist that greed and evilness is deeply rooted in the heart of  private sector and big “bad” corporations, and only the angel, i.e. the government, can and always benevolently acts as the savior of the earth.

Let’s set aside for a moment the debate on who (private sector or the government) are more greedy (there are certainly more government corruptions than corporate scandals, don't you agree?), and see some hard data first.

The World Bank’s survey results recently released show that, within China, wherever private sector prospers, more efforts are exerted to improve on environmental standards, and residents enjoy not only higher wage but also cleaner air and more green space. When state-owned firms dominate, the reverse happens.

The reason is quite simply: private sector development increases government’s tax revenue, which is necessary (although not sufficient) for the conduction of environmental projects. We always hesitate to talk about money when it comes to environmental protection. How dare we introduce the sinful money into the purest domain of human race: environmental protection?  We sometimes think.

But the cold truth is that: to carry out environment-improving projects, you need money more than lip services. As Dan Harris in the China Law Blog rightly points out: “Copenhagen can afford a state of the art sewage system; Freetown, Siera Leone cannot.”

Certainly private sector development is not a sufficient condition for better environment, but we do know that state-owned firms are always the worse polluters.

The World Bank’s China country office surveys 12,400 firms in 120 Chinese cities. It is found that private sector development varies across China. In Wenzhou and Jiaxing, 99% of the firms are privately owned, while in the old Northeastern rust belt, only 60%. The cross-city variation of private sector development is then closely associated with local environmental standards.

According to an article written by David Dollar (World Bank's China country director) for the Newsweek:

“A good investment climate for firms also goes hand in hand with a good environment for people. As expected, cities with better investment climates tend to have higher wages (averaging $3,000 to $4,000 a year in coastal cities, versus $1,000 in the interior), less unemployment, lower infant mortality and higher education spending.

But surprisingly, they also score higher on environmental measures such as green space per capita, clean-air days per year and percent of water discharge that is treated. For example, cities like Weihai, Qingdao, Suzhou, Hangzhou and Fuzhou all score very highly in terms of business climate, and all treat 97 percent or more of their industrial waste water, with Weihai treating a perfect 100 percent.The opposite is also true. The average waste water treatment rate for cities with poor investment environments was about 78 percent. Why is this so? Cities with poor investment climates tend to have industry dominated by state firms, which often are the worst polluters.”

In an article "China's Pearl River Smells, But the Mayor insists to Swim in it" I posted in this Bulletin some time ago, I reports on the improved river water quality in Guangzhou, a southern Chinese boom town.  An American teacher living in that city comments with his/her first hand experience that the river still smells badly. It is very true that the river still smells. But five years ago, it stunk and it could hardly be called a river. And the river’s water quality is still much better than other Chinese cities.

Why? The reason is very simple. Guangzhou is one of the richest cities in China, and government tax revenue grows at 40% a year, and residents who are now better off financially are very sensitive to the environments surrounding them. Everything comes naturally after a country or a city gets richer.  London stunk too in the 19th  century.

Without private sector development, there certainly will be no greed, no pollution, because the earth will become a large zoo with all human beings living primitive lives. Note that these do not include some half-hearted prominent environmentalists residing in rich countries. They will still stay in New York, complaining about air pollution, and telling media how much they love Africa, as their zoo.

Finally, I have to emphasize that, to re-forest the earth, you need to plant more trees instead of consuming less paper. Research shows that the average American consumes the equivalent of one mature tree every year. This means that, however hard you try, you cannot save more than one tree even if you restrain from using any paper-related products.  But when you use less greeting cards, those people in developing countries who make these cards lose their jobs. I am quite curious why we are making so much fuss about sending paper Christmas cards. Isn’t it more efficient to donate some money to plant more trees instead of going through so many hassles to save one tree every five years?  No.... then a lot of lobby groups will lose their jobs. It is politics, stupid.

Note: I don’t think these “environmentalists” are true environmentalist. To qualify as a true environmentalist, you have to care about lives of the local people more than your daily media coverage. In the case of some labor unions, don’t disguise your own agenda as “helping poor people in developing countries”. If you truly want to help out, let the most capable and hardworking people from the developing countries compete with you and take your job.  And when you say you hate the pollution in New York and like to turn it into Amazon jungle, you must have a concrete plan to move to live in Amazon jungle, and let the local Brazilians to move here to occupy your apartments. Isn’t it a perfect exchange program: you want natural forest, and they want higher living standard. Kenyans are not stupid either, and they don’t want to live in a zoo watched by you, no matter how you portrait nomad life as a perfect integration with the environment. Enjoy it by yourself if you like it.

Deutsche Bank’s take of China, India, Brazil and Mexico: Reports

Below I put together a collection of country research reports produced by Deutsche Bank Research, on several important emerging economies. Let's see what are Deutsche Bank's take of Goldman Sachs's BRICs.

China 2020: challenges ahead (PDF file)
China should be able to achieve high growth for another decade, moving its GDP above that of most industrial countries. Challenges however include a fragile banking sector, rising unemployment, large government debt, and corruption within the one-party political system.

India rising: a medium-term perspective (PDF file)
GDP per capita will double in 2020. Favorable demographics, increasing investment in education and infrastructure and further integration with the world economy are the factors behind DB’s projections. IT-related services, textiles, and the auto-ancillary industry and pharmaceuticals are expected to gain dynamism given India’s comparative advantage.

Brazil: O pais do futuro? (PDF file)
Grow at an average of 3.3% year. Competing against China, Brazil is likely to maintain its position in niche high-tech sectors where it has a competitive advantage. Increased Chinese demand for commodities will provide Brazil with an opportunity to move up the value chain in commodity-related sectors.

Mexico 2020: Tequila sunrise (PDF file)
Geographic closeness to the US gives it an unique advantage. There is fair chance that Mexico’s industrial profile will make a successful transition from low value-added to more sophisticated products.

CLSA: China manufacturing price will have to rise

According to CLSA’s latest Purchasing Manager Index (PMI), Chinese manufacturing firms are having a very good time:  production up, employment up,  incoming business up, new export orders up, backlogs of work up, stock of inventory down. China is (over) heating!

The overall effect for foreigners however is that consumer price and interest rate will move up inevitably in the next several months. I am not sure whether this will continue for ever; based on estimated capacity of power plants and steel mills under construction, in 2007 both electricity and steel capacity in China will exceed demand (currently there is a shortage of both) and the trend of rising input costs is likely to slow down.

According to the CLSA report:

“Production rose for a sixth consecutive month in May, at a rate close to April’s eleven-month high. Output was led higher by increased volumes of incoming new business, which rose at the strongest rate in thirteen months. New order gains were driven by robust demand from both domestic and foreign clients. Growth of new export orders accelerated to the sharpest for twelve months during May.

     Backlogs of work rose for the third consecutive month, with the rate of growth picking up to the sharpest since last December. A number of firms met increased sales from warehouse inventory, contributing to further contraction in stocks of finished goods.

     Latest data highlighted a rise in employment at Chinese manufacturing firms for the second month running in May, though the rate of hiring remained only marginal.

     The quantity of inputs purchased by firms continued to rise in May, with the rate of growth quickening for the fourth straight month to its strongest since April 2005. This contributed to a further expansion of pre-production inventories. Supplier lead times were found to have lengthened slightly for the fourth consecutive month in May, reflecting stronger demand for inputs.

     The rate of input price inflation in the Chinese manufacturing economy surged from April’s already strong pace to a fourteen-month high in May, as 44% of panellists signalled a rise in their average purchase costs since the previous month. Firms widely reported higher prices paid for oil and related products, as well as chemicals and metals.      In order to offset rapidly rising input costs, manufacturers raised their charges again in May. The rate of output price inflation was robust and the sharpest since March 2005, but was still well below that of input prices, reflecting intense competition in a number of markets. This suggests a further squeeze of profit margins.”

Go head, learn Mandarin? There is no need.

The TIME magazine says that now we need to start learning Chinese Mandarin, because “ to an extent, this is a case of history repeating itself—with a twist. Just as Americans started studying Japanese in droves in the 1980s, when Japan's economy was ascendant, so today, as China rises, the world is embracing Mandarin.”

But in any case, Japanese businessmen speak English if they do business with foreigners and it takes a lot of patience for them to wait for you to practice your basic and broken Japanese in the meeting room in a serious negotiation. Japanese may not speak English very fluently, but communication and business can already be done at that level . If it is a very important billion dollar deal, go hire a first-class translator. Language, friction it certainly is, is never a formidable barrier for doing business.

Some basic greetings and conversation skills may be needed, as TIME ends the article by quoting someone who is practicing Chinese: "But we weren't sent here by the company. We're drinking buddies, and decided to do something more constructive with our time than guzzling beer." Indeed, to make your life less boring when meeting Chinese businessmen and on a business trip, this is useful.

But in any case speaking Mandarin (unless you really master the language at decent level) is torture for both you and people on the other side of the negotiation table. True, in South Korea, 160,000 high school and university students are studying the Chinese language, but they are moving to China and many plan to settle there; this is a different story.

Nevertheless, speaking a little bit (not neccesarily much) local language helps you make friends and brings you unexpected favors. According to TIME's Beijing correspondant Susan Jakes:

"The more boldly I stammered through basic conversations, the more people seemed to attach themselves to me as unofficial teachers. In Beijing, a woman once invited me home for dumplings when I said "excuse me" after bumping into her on a crowded subway. A Harbin cop took me driving in his new Mercedes, and a couple I met in line at a bank included me in their family bowling nights. Each invitation was an opportunity to make mistakes and collect new words: "home cooking," "special privilege," "gutter ball." "

China or India, who’s got sweatshops?

China is known for its labor-intensive low-wage manufacturing. But according to Mercer Human Resource Consulting: software engineers, sales staff, financial analysts and factory workers all earn more in China than India.

AVERAGE ANNUAL PAY-CHINA (in British Sterling)
Project manager: £12,173
Software engineer: £6,998
Accountant: £4,677
Sales rep: £2,649
Production worker: £1,214

AVERAGE ANNUAL PAY-INDIA (in British Sterling)
Project manager: £5,220
Software engineer: £5,344
Accountant: £2,956
Sales rep: £2,464
Production worker: £964

According to a report in The Australian, in the newly-completed Toyota factory in Guangzhou, China, workers, 3500 of them, are paid about $2.70 an hour. Note that these are assembly-line workers, not IIT-educated genius.

Labor regulations never get you higher pay; Market foreces and your own skills do!

Is Nicholas Kristof an idiot? the "******* vs. Netizens" case

Nicholas Kristof, op-ed columnist of New York Times, publishes an article today describing how he tests the limits of the Internet in China.

He started several blogs in Chinese internet service provider, and find that however political sensitive words he includes in the blogs are not deleted, but are just replaced by ******. He thus claims it to be a victory of Netizens, that Internet police are not able to control numerous blogs mushrooming in China.

Yes, Nicholas, you are very smart that you find this loophole in the system.

But everyone knows it too, just no one else is stupid enough to disclose it publicly.

Everyone, except you, understands that the loophole will be closed once it is disclosed publicly.

Provision of  Internet service, including hosting of blogs, is a very competitive business in China. In order to attract users, most providers will always “walk on the edge of the law” and try to create as little inconvenience to users as possible.

This includes, not removing “sensitive words” as the state censors require; instead, they simply replace the words with ******.  Technically, by doing this, Internet service providers violate the law, but the Internet police don’t bother to interrupt. I guess there is implicit agreement between them: Internet police want a quite life; Internet service providers want profit; Thus, police will leave service providers alone unless big troubles are made that humiliate the Internet police.

As a by product, Chinese netizens get a little bit more freedom than the law provides.

This will be soon gone, after Nicholas Kristof’s stupid move; typically the state will feel very embarrassed and feel publicly humiliated (in New York Times!), and then the Internet police will be reprimanded. And boy, who are the ultimate victims? The netizens!!

I still don’t understand why Nicholas Kristof publicizes this. To raise awareness? I guess everyone already knows that Chinese government censors Internet, and what Nicholas is telling us is no big news. Even when you want to raise awareness, there are many better ways that are much better than publicizing a loophole that has been benefiting Chinese netizens!

Certainly, you will say that the ultimate blame should be the government, and Kristof is only the little boy who tells everyone the Emperor has no clothes.

But why do we care whether the Emperor dresses or not!

See Kristof's op-ed article: "In China it's ******** vs. Netizens"
(Sorry I copy this NYT article without permissoin, but considering the great harm he's done to one hundred million Chinese netizens, I think Nicholas should allow me to violate his copyright for several days as a compensation)

Update: So far the two "test blogs" are yet to be closed down.

Should journalist use lies to fight lies? The Apple “slave” labor case

Apple is running into trouble recently. A recent U.K. newspaper report claims that workers at a Chinese iPod factory were working long hours, for little pay, and in "slave conditions". They were said to have been earning $50 a month (or about $1.60 a day) while working 15-hour shifts. The reporters visited two plants in the crowded country, one close to Shanghai and the other near Hong Kong. One, described as iPod City, was said to have 200,000 workers who lived in dormitories on the site.

Labor compensation is really terrible in China, but I don’t think these journalist should use lies to fight lies.

First, in the two locations where the journalist claim they investigate (I guess one in Kunshan and the other in Shenzhen), it is impossible to hire assembly workers at $50 /month. It is just impossible, not because the employers are benevolent, but because factories next doors will recruit away all you workers at the prevailing market price if you offer only $ 50/month.

Reading the report  carefully (I guess most readers will only remember the headline numbers they throw out instead of finishing the whole report),  however, you will find that $50/month is not the wage, but the net saving after deducting expenses as calucauted by the journalists. Should we say that some American workers are paid zero dollars/month because they rarely save money?

Interestingly, the real monthly salary number (about $100 /month) obtained by the journalists (I guess the number should be real, as journalists do not have incentive to over-report the number) meets the minimum wage requirement, which many labor activists believe to be fair but don't think are actively enforced! The report unexpectedly provides evidence that minimum wage law in China does have teeth!

$100 /month is small sum for British, but it is a lot of money in China. Why don’t the journalist make some attempt to put the number into perspective. In inland provinces, government employees (dream position for most local residents ) are paid $100/month.  $300/month is also three times what Indian workers can get.

Why don’t the journalist tell readers what are the alternative income these workers could get if they don’t have a job in the  factory?  It is a poor country, and $100 /month is exactly the same as the country’s GDP per capita. The average monthly British GDP/per capita is over $2800, will you call a British worker who are paid $2800/month a slave!!

Second, in the past five years, Apple sold 42 million i-Pods. If 200,000 workers are employed to produce i-pods, then each worker produced only 210 i-pods so far.  Don’t you think such productivity is ridiculously low. A Washington Post article reveals that the factory is not owned by Apple, but by a contract manufactures Hon Hai precision Industry, also known as Foxconn electronics Inc.  Foxconn does employ 200,000 workers, but Apple is only a client, and only small fraction of the 200,000 workforce work on i-pods.

I really don’t know why the journalists want to throw out a sensational number of "200,000 workers", and the so-called “iPod city” name, just to exploit the popularity of iPod brand name?  And “the 200,000 workers in one site” description also tries to get readers to have an impression that all 200,000 workers are fit into one dorm room!

I want to say to the journalist of Mail on Sunday (the U.K. newspaper that reports the story): 
The best weapon of journalists is fact and truth, if you degrade yourself to the same level of a lying regime, you bring shame to the whole journalist community!

Interestingly, Mail on Sunday doesn't put the report online. Are you fearing of sunshine?

Reference:
Sweatshop conditions at iPod factory reported
Apple eyes labor conditions at iPod plant

Update:

found that Perry Wu in the ChinaTechNews.com has the same views as mine, in his article "Hyperbolic Apple iPod factory woes"

Sun Bin recommends a blog post "A Chinese view of iPod City", which provides a nice summary of the event and coverage. Thanks.

China’s pollution and sweatshops revisited

Two recommended articles, both from New York Times:

(1) China’s burning of coal casts a global cloud

China’s increasing pollution due to use of coal in generating electricity  has become a global problem as the West Coast states of the U.S. also suffer from polluted dusts that can move thousands of miles across Pacific Ocean . At the end of the article, however, the reports also remind us that an average American still consumes more energy and is responsible for the release of 10 times as much carbon dioxide as the average Chinese, and thus it is still not time for finger-pointing.

(2) In praise of the maligned sweatshop

Nicholas Kristof tells us why students campaigning to boycott “sweatshops” in developing countries, however well-meaning they are,  are actually harming poor people badly, and why students should actually campaign  for more “sweatshops”.

Without sweatshops, poor people won’t be exploited. It is true, because they starve and die instead! which some self-righteous students don’t care about any way.

Morris Goldstein and Nicholas Lardy’s solution to Chinese currency problem

Morris Goldstein and Nicholas Lardy’s solution to the Yuan problem:

“...we propose the following compromise. First, China should implement in the next few months a 10 to 15 percent appreciation of the renminbi relative to the current value of the basket. This could be done either by a revaluation or by allowing market forces to push up the currency’s value. Such a “downpayment” would help to persuade external critics that China is serious about controlling its growing external imbalance. Second, China should widen substantially either the band around the central rate or the daily fluctuation limit. That would provide increased independence for monetary policy, allow scope for further renminbi appreciation and give China experience in managing increased flexibility. Third, to offset some of the contractionary effect of the renminbi appreciation, China should simultaneously implement fiscal expansion. Fourth, China should maintain most capital controls until its banks are further strengthened.

This would still require sizeable real appreciation of the renminbi later, with all the problems that such a phased adjustment entails. If speculative inflows resurge, the authorities would need to choose between an acceleration of renminbi appreciation and a temporary recourse to tighter controls on capital inflows. In the final stage of currency reform—when China’s banking system is more stable—China would float the currency and remove the remaining capital controls. Admittedly, this is not an elegant plan. But if it would break the existing logjam in addressing global payments imbalances, it merits consideration.”

see Goldstein and Lardy's full article in the Finanicla Times

How cheap is Chinese labor? U.S. Department of Labor has the answer for the first time

Contracted by the U.S. Department of Labor, Judith Banister, famous for her estimation of Chinese death number (30 million) in Great Leap Forward, has put out a number on average wage of Chinese manufacturing workers.

According to the report, in 2002, Chinese manufacturing employees are paid on average 57 cents/hour, and those in cities are paid twice that amount. In comparison, U.S. manufacturing workers are paid   $21.11/hour, and Mexican workers are paid $2.48/hour.

57 cents/hour however is not a bad deal for many Chinese workers. Because China’s living costs are low, it is equivalent to nearly $3 dollar/hour adjusted for purchasing power.

The numbers are based on 2002 though. In the past four year, particular after 2004, wage level hikes in Chinese manufacturing factories, so the latest number should be much higher than that.  According to London-based EIU (Economist Intelligence Unit), labor costs last year has reached $1.36/hour, 72% higher than in 2001, and in 2010 they will be double again.

"It is not just wage that is going up; companies are having to buy air conditioners for employee dorms, provide better food and make the enviroment better for workers"  according to Michael Kleist, author of Global Sources' China Supplier Survey.

Banister also points out that, Western companies shouldn’t expect to pay only 57 cents per hour (not even in 2002), because foreign-owned factories are usually located in cities, and hire skilled workers who earn more. 

Evidence seems to point to the direction that cheap labor is not the only reason why Chinese excel in manufacturing. Wage level in India is much lower.

The longer reports:
manufacturing employment and compensation in China (pdf file)
Two shorter reports:
Manufacturing employment in China  (pdf file)
Manufacturing earnings and compensation in China  (pdf file)

You may also want to read a previous post on this Bulletin,  on Chinese minimum wage

What’s so special about China’s exports? They are too sophisticated.

One special characteristic of Chinese exports is that they are too technologically sophisticated for a typical developing country at this stage of development. Certainly it is sometimes foreign parent companies that control the most value-adding stage of the production chain of these products, and Chinese may not contribute that much technologically, there are benefits associated with such an export pattern.

According to new study Harvard professors Ricardo Hausmann, Jason Hwang, and Dani, this export pattern is beneficial to China’s future growth, because knowledge can spillover from these sophisticated productions, while in countries specialize in commodity exporting, they may not have a chance to learn at all.

What You Export Matters (pdf file)
When local cost discovery generates knowledge spillovers, specialization patterns become partly indeterminate and the mix of goods that a country produces may have important implications for economic growth. We demonstrate this proposition formally and adduce some empirical support for it. We construct an index of the "income level of a country's exports," document its properties, and show that it predicts subsequent economic growth.

Also see their case study of China:
What’s so special about China’s exports? (pdf file)

Robert Mundell: don’t push China to revaluate currency!

Nobel economist Robert Mundell gave a lecture on the Chinese economy, in Simon Fraser University, BC.

Below quoted from the Calgary Sun:

"I don't think China will accept it," said Mundell. "It's moreover not a good policy for the United States or the IMF to push because it would do countless damage to the poorer parts of the Chinese economy."

While China is the most successful of the world's emerging economies, it still has 80 million people living on less than $1,000 US a year.

Boosting the yuan by the 40 to 50 per cent that some have demanded would make their products instantly uncompetitive, Mundell warned.

"Appreciation would be devastating to those people," he said.

Mundell noted the Japanese economy ground to a halt for most of the 1990s and its banking system collapsed after Japan agreed to boost the yen.

Removing exchange controls by allowing China's currency to float would be equally damaging as Chinese demand for dollars exploded and the yuan tanked, Mundell argued.

Finance professors rush to China

2006 seems to be a Year of China for economics and finance professors. Although many professors already realized the importance of China very early on, it is in this year that people start to think that the next research frontier has to be China, and you better start working on some China-related topics before others publish them. Professors are no different from multinational corporations that rush to China to seek for profits.

A keystone is that the Financial Intermediation Research Society, a prestigious association of U.S. and European finance professors, headed by Wharton Professor Franklin Allen, decided to host its biennial conference in Shanghai, China.

Here I recommend two papers by Franklin Allen that I think can help you better understand the past, present and future of China’s financial system. They are not very technical papers, so you shouldn’t need any academic background to understand them.

China's Financial System: Past, Present, and Future  (pdf file) (by Franklin Allen, Jun "QJ" Qian, and Meijun Qian)

Abstract:  We examine and compare the role of China's financial system in supporting the growth of firms and the economy with that in other countries, and explore directions of future development. First, we find that the current financial system is dominated by a large but inefficient banking sector, and reducing the amount of non-performing loans among the major banks to normal levels is the most important objective for reforming the financial system in the short run. Second, despite the fast growth of the stock market, its role of resource allocation in the economy has been both limited and ineffective. Further development of China's financial markets is the most important long-term objective. Third, we find that the most successful part of the financial system, in terms of supporting the growth of the overall economy, is a non-standard sector that consists of alternative financing channels, governance mechanisms, coalitions, and institutions. This sector should co-exist with banking and markets in the future in order to continue to support the growth of the Hybrid Sector (non-state, non-listed firms). Finally, in order to sustain stable economic growth, China should aim to prevent and halt damaging financial crises, including a banking sector crisis, a real estate or stock market crash, and a "twin crisis" in the currency market and banking sector.

Law, Finance, and Economic Growth in China  (pdf file)

Abstract:      China is an important counterexample to the findings in the law, institutions, finance, and growth literature: neither its legal nor financial system is well developed by existing standards, yet it has one of the fastest growing economies. We examine 3 sectors of the economy: the State Sector (state-owned firms), the Listed Sector (publicly listed firms), and the Private Sector (all other firms with various types of private and local government ownership). The law-finance-growth nexus established by existing literature applies to the State and Listed Sectors: with poor legal protections of minority and outside investors, external markets are weak, and the growth of these firms is slow or negative. However, with arguably poorer applicable legal and financial mechanisms, the Private Sector grows much faster than the State and Listed Sectors, and provides most of the economy’s growth. This suggests that there exist effective alternative financing channels and governance mechanisms, such as those based on reputation and relationships, to support this growth.

What are in the Chinese currency basket?

Officially Chinese Yuan is not pegging USD, but a basket of currencies that include mainly USD, Euro, Japanese Yen, Korean Won, and various other secondary currencies. The precise weight of each currency in the basket is however confidential. As a matter of fact, it is actually not clear whether the basket actually exists, or whether USD actually makes up 100% of the basket.

Many private sector analysts have been doing some reverse-engineering to back out the weights by regressing USD/Yuan rate on movement of other major currencies.

T-A-C Financial Research, for example, reports that USD’s weight in the basket is estimated to be 33%, while weights for other currencies are 11% for Euro, 30% for Japanese Yen, 16% for Korean Won. Morgan Stanley’s estimate of USD’s weight is much higher at 43%.

According to a report by T-A-C (pdf file), the predicted weights fit the actual movement of USD-Yuan rate very well in 2005, with a R-Squared of over 90%. Using this weighting scheme, Based on consensus forecast of USD exchange rates with other major trading partners, T-A-C forecasted in September 2005 that  USD/Yuan rate will on average reaches 7.99 in August 2006. In the most optimistic situation, Yuan may appreciate to 7.91.

Certainly, all of these forecasts of Yuan movement are conditional on China’s actually using a weighting scheme (as opposed to human discretion) to set the exchange rate  and the scheme will remain unchanged.

Yuan needs revaluation, not flexibility (volatility)

Should Chinese currency Yuan’s exchange rate be made flexible? Or should we be happy with just a large revaluation (and then fix it there)?  At least currently these two goals are consistent, as everyone expects Yuan to revaluate once flexibility is allowed. But in the longer term, Yuan can move in both directions, and we need to evaluate the pros and cons of it.

A new research (done by professors Philippe Aghion, Philippe Bacchetta, Romain Rancière and Kenneth Rogoff ) suggests that it may not be advisable to introduce flexibility (volatility) too early into Yuan when China is still a financially underdeveloped country. Their theory and empirical evidence shows that, for countries with relatively low levels of financial development, exchange rate volatility generally reduces growth.

Then I think an unidirectional revaluation of Yuan upward would suit the needs of both Chinese and Americans, since no one is actually demanding flexibility (I guess the Congress will explode if China were to devaluate Yuan, although it is also a “flexibility” intepreted literally)

Now that we establish that what everyone wants is just a revaluation, then one proposal could be: Using government (not market) force to gradually lower the Yuan-Dollar rate to 7 or even 6 (to appease some American politicians), and fix it there after 2008 U.S. election (after which I think the need to use China as a scapegoat will be gone),  until there is need in the Chinese’s side to further adjust the exchange rate.

Exchange Rate Volatility and Productivity Growth: The Role of Financial Development (PDF file)
Abstract: This paper offers empirical evidence that real exchange rate volatility can have a significant impact on long-term rate of productivity growth, but the effect depends critically on a country's level of financial development. For countries with relatively low levels of financial development, exchange rate volatility generally reduces growth, whereas for financially advanced countries, there is no significant effect. Our empirical analysis is based on an 83 country data set spanning the years 1960-2000; our results appear robust to time window, alternative measures of financial development and exchange rate volatility, and outliers. We also offer a simple monetary growth model in which real exchange rate uncertainty exacerbates the negative investment effects of domestic credit market constraints. Our approach delivers results that are in striking contrast to the vast existing empirical exchange rate literature, which largely finds the effects of exchange rate volatility on real activity to be relatively small and insignificant.

A disturbing inside peek at China's financial mania

Christopher Whalen has some great insights into Chinese banking sector in his article “The Next Great Pyramid Game: a disturbing inside peek at China’s financial mania” . Investors, read it before buying into Chinese banks!

“China’s leaders do not recognize or even understand what it means to operate private banks with private borrowers and private property in a market economy where corruption is not the dominant factor in everyday life.”

“China’s economy is like the old burlesque comedian with a loose string that when pulled disintegrates his suit.”

He however does have some hope on the ongoing baking reforms in China.

“If American manufacturers think they are having a tough time competing against Chinese manufacturers now, just wait until the day Chinese manufacturers have access to capital at market rates!”

Why I think Peter Morici is wrong in Chinese currency revaluation issues?

Dr. Peter Morici (University of Maryland) is a dedicated China-basher on Yuan revaluation issues. His articles on Yuan revaluation issues appear in numerous national and international  newspapers. I agree that China should allow more flexibility in Yuan exchange rates and it is in China’s own interests to let Yuan appreciate. But the reasoning based on which Dr. Morici reach his conclusion is problematic.

Let me comment on them one by one. Let's start from: “It’s high time for John Snow to cite China for manipulating the Yuan” – in Finfacts, Ireland

“US Treasury Secretary John Snow will soon issue his semiannual report on the currency policies of major trading nations....Secretary John Snow should determine that China manipulates the yuan to obtain an unfair competitive advantage. Sadly, he will likely again deny sound economics and finesse the issue.”

“Should determine”? I shall “determine” that from now on the sun will rise from the west? Does the world work in such an egoistic way? And I feel particularly disturbed that he think whoever don’t think the same way as he does is not “sound economics”

“China to obtain an unfair competitive advantage”? Seems that most of China’s exporters are foreigner-owned. Is Dr. Morici saying that some hard-working American entrepreneurs are gaining an unfair advantage against some American vested interest (unions, etc)?

“International trade and investment flows best promote global prosperity and progress in developing countries when those reflect comparative advantages and national differences in market-determined rates of return for capital. Exchange rate adjustments are vital for ensuring that national trade and investment balances reflect these fundamentals and promote the efficient geographic dispersion of production.”

I think it is quite true. So why doesn’t Dr. Morici accept that fact that many manufacturing tasks are not American’s comparative advantage any more?

“For example, the 1997 Asian currency crisis was caused by overvalued currencies, such as the Korean won, engineered to allow manufacturers to buy western capital goods and technology on the cheap. These required borrowing dollars to support currency values and betting those loans could be repaid with future export earnings."

Doesn’t Dr Morici know that currency overvaluation is simply redistribution of profits from Korean net exporters to Korean net importers, and for those who import machines and then export final products, the effects are more likely to be canceled out?

Also, does this mean that Americans consumers are buying goods “on the cheap”. Then why the complaints? It’s redistribution of profits from some low-tech American manufacturers to American consumers. If you feel it is unfair, go legislate a law to tax American consumers and use the proceeds to compensate unemployed American workers. It is simply an American domestic issue.

“(In Korea....) When bad investment choices and corruption kept export enterprises from paying out as needed, dollar denominated loans could not be repaid and calamity followed. Speculators were tarred but it was the stupidity of finance ministers that precipitated the crisis.”

Who is to be blamed for the Great Depression then? Treasury secretary of the United States?

“In the 1980s and 1990s, Japan prosecuted a mercantilist assault on European and North American durable goods industries by purposely undervaluing the yen. When rising wages and other costs finally limited export-led development, Japan’s economy sputtered, and it has suffered a decade of stagnation.”

Don’t disseminate false information. Let me correct you. Japan fell into recessions because she yielded to the pressure of the United States and drastically appreciated Yen.

“Clearly, China’s currency practices create an unfair trade advantage and are one reason manufacturing is not enjoying the same scale of expansion as the rest of the U.S. economy.”

Why should manufacturing enjoy the same scale of expansion as the other sector at all? Manufacturing employment share has been declining for decades. (remind you: China was busy in Cultural Revolution at that time and wasn’t doing business with the U.S.  Who else do you want to blame then?) America prospers because she keeps moving away from low value-added manufacturing to higher valued-added services, research and development. It is an inevitable trend!

“Given China’s development status and trade surpluses, this pattern of official reserve purchases may be fairly characterized as currency manipulation. It may not be reasonably characterized as anything else.”

Remind me of: “Given that this person is Black or Hispanic, he may not be reasonably characterized as anything else other than a murder.”  What an interesting conclusion!

“Sooner or later, China will reach the limits of its ability to sell cheap goods in the United States. With its surplus of underemployed labor, rising wages won’t pose too much of a problem. However, Wal-Mart can only sell so many cheap gadgets, and if China steals too many U.S. jobs, stagnant wages will severely constrain U.S. demand for its products.”

Why do you think Chinese won’t move up the value chain? And based on what do you established that China “steals”?  Are theses jobs owned by the U.S., and not allowed to be occupied by poor people outside the U.S.? So whoever defeat you is stealing from you?

“China’s drain on oil and other global resources, and the inflation that creates, is about to preview that phenomenon”? Doesn’t the United States consume oil and global resources as well? So you don’t allow others to consumer too?

And an undervalued Yuan create inflation in the U.S. ? What kind of economics is this, Dr. Morici?

China's Patients, Students Create U.S. Deficit!

Bloomberg columnist Andy Mukherjee points to China’s lack of domestic demand as an important cause of her trade surplus.

Facing escalating housing, health care and education costs, Chinese people feel very insecure in spending and hoard up lots of cash for precautious reason. This reasoning is nothing new to most researchers of China, but I still want to draw your attention to  the title used by Andy Mukherjee for the article, which  strike right on the target: “China's Patients, Students Create U.S. Deficit!”

“.... In some Chinese hospitals, patients must wear stickers indicating how much they can pay to get well. With the quality of treatment linked to the patient's financial means, unexpected illness is among the biggest reasons Chinese families are some of the world's most committed savers.  And it is China's frugality -- the savings rate has doubled in the past four decades to 50 percent of gross domestic product -- that's making it possible for the U.S. to overspend and run a record-high current account deficit, most of it with China. Politicians in the U.S. blame China for manipulating its currency to gain an ``unfair'' export advantage.  They probably don't realize that a substantial part of the U.S. trade gap is actually being created in China's hospitals and schools, which act as limitations on what the Chinese are able to buy from the rest of the world.”

Andy is quite right that the solution is quite easy (at least easier than currency revaluation): sharply increase public expenditure in education from the shameful current level of a paltry 3 percent of GDP, among the lowest in Asia. I couldn’t think of any other investment in the world than education that can guarantees you great returns. An educated nation will never lose in competition.

As Andy points out, “Public provision of good-quality health care, education and housing has played a large role in Singapore's economic success and political stability over the past four decades.”  I know Chinese (government) likes stability, and here is the road to stability.  Provide everyone with decent housing, healthcare, and most importantly, great education, and you won’t miss the goal of rising to the status of  a great nation.

In the meantime, you solve the global imbalances problem too!The world will be grateful to you.

World Bank or Chinese government: who’s got a deeper pocket?

World Bank’s planned five-year quota (2006-2010) on loans to China is merely $1.5 billion. China probably spends much more than this amount in one single African country, and sometimes without requiring for repayment.

What China needs from the World Bank is not money, but technical assistance on both technology and governance. Some American politicians try to use World Bank loan to pressure China by threatening to withdraw lending. It is going to work only in opposite direction.

When China receive nominal amount of $1.5 billion from the World Bank, she at least shows a gesture of opening herself to outside influence. Merely $1.5 billion gives the World Bank a foothold in China, to exert her influence in among other areas environmental protection, institutional reforms, better governance.

The whole deal is not about money. Financial aid is never about money. It is about exchange of ideas and strengthening of relationships.

P.S., China receives about 650 million USD of low-interest loans annualy from Japan, which is planned to be terminated before 2008. The amout is certainly greater than what the World Bank extends to China, but again, it is very small compared to China's domestic saving, and this type of loans is always more a good gesture of friendship rather than real financial favor.

The Financial Express: World Bank offers $1.5 b loan to China 

BEIJING, MAY 28:  The World Bank has pledged to lend up to $1.5 billion in loans to China annually between 2006 and 2010 to help the communist giant’s smooth integration into the world economy and face other challenges, including reducing poverty. 
RP eyes $32b China loans

Reuters: China to lend Nigeria $1 billion to fix railways
BEIJING (Reuters) - China will give Nigeria a $1 billion loan to fix its dilapidated railways, Xinhua news agency said on Monday, in another sign of China's growing economic sway across Africa.

Manila Standard Today: RP eyes $32b China loans
The Philippines is looking to tap $32 billion in concessional loans and other credit facilities from the People’s Republic of China to finance major projects, including infrastructure, agriculture and mass housing.
(note: I am not sure about the unit of the currency, as the numbers in the main text does not add up to $32b)

Chinese leadership signals support for further reform

China’s party newspaper People’s Daily carries an editorial today urging members to “unwaveringly uphold reform”. This is supposed to silent the rising leftist advocates and disassociate and distance the top leadership from conservative old guards. The editorial is signed by a famous pseudonym “Zhong Xuanli”, in Chinese rhyming “Central Propaganda Department’s Theoretic  Research Division”

For background of the heated debate, please refer to a previous post in the Bulletin: “Socialism or capitalism? New turning point in China?”

Financial Times:  Chinese leadership signals support for further reform

"The mouthpiece of China’s Communist party on Monday urged that members “unwaveringly uphold reform” in a call seen as an attempt by Beijing’s top leaders to silence opposition to wider foreign and private involvement in the economy.

A People’s Daily newspaper article that received extensive attention from other state media and was clearly intended to represent party policy, said China had no choice but to deepen market reforms and open further to the outside world.

“If we do not drive ahead with reform, not only will we be unable to win new achievements, we will also find it hard to maintain the progress we have made in the past,” the article stated.

Its publication follows unusually open and heated criticism during the past year of government policies on issues such as foreign takeovers of Chinese companies and management buy-outs of state-owned enterprises, all set against a backdrop of rising social inequality."

Other media coverage (more will certainly follow; I am particularly interested in how several major U.S. newspapers will interpret the story tommorow):

Times (U.K.) China's secret row bursts into the open

Why should governments build roads (only)?

The involvement of government may be necessary in provision of goods and service that private sector is not interested in, e.g. universal and free education. When competing for profits with private sector, however, governments universally make things worse.

Nevertheless, I argue that you should let government build roads, a lot of roads. The point is that, you need to keep government very busy doing something less disastrous (e.g. building roads), to prevent it from intervening in areas where history has proven that government is very capable of messing thing up, e.g. producing cars.

Building roads are one of such tasks. Building a road from point A to point B, there is not much discretion left to the government to create disasters. Even if officials embezzle half of the funds, the costs of the roads is only twice of the market price. It is already a bless because the government may waste all of the money if you ask it to build a car factory instead.

As roads are such homogenous products, it is actually quite difficult for officials to overprice the costs too much (certainly, they are always overpriced). And as roads are there to stay for decades, you will get caught at some point if you substitute too much sand for concretes to enrich yourself. If you are manager of a state-owned manufacturing company however, by the time you leave the position you can already clean up all the traces of your crime and you can always blame poor decisions for the investment losses. It is much difficult to prove your corruption than when you build roads.

Regarding whether China is building roads that are wasteful and lead to nowhere, I doubt it. Typically newly-built roads are flooded with traffic within 1-2 years. In a densely populated country such as China, it is too difficult to build a road that can lead to nowhere. It is much better than to build monuments, which is completely waste of money.

Xaiver Sala-I-Martin has an interesting collection of photos on how inefficient governments are in constructions.

Governments are stupid, but they are entrenched, and it is unrealistic to get them downsized. They always want to prove the value of their existence.  A compromise solution  believe to be wise is to get governments to build roads, a task that they are “less bad in”. When building roads, they may make some funny mistake as Sala-I-Martin shows to us, but let’s just take them as daily laughter. Life is not perfect, you cannot always get the first best solution.

Latin America vs China: a more meaningful topic than India vs China

Many people are tired of the India vs. China debate. After all, India and China are more likely to be complementary than substitute for each other. One is better in hardware while the other is better in software, there is more opportunities for cooperation.

There absolute loser from China’s rise in world production is actually Latin America. Latin America has much higher wage level than China, Thailand, or Malaysia. The region however is much backward in production technology. This is not going to be sustainable. In a “flattened world”, no importers are willing to pay higher price for lower quality products.

Jeffery Sachs used to say: the problem of Argentina is not fiscal policy, but how it is possible that a country like Argentina, with per capita income as high as 10,000 USD, is still engaging in low knowledge-intensive productions.

It is not sustainable. You need to overhaul your education system and upgrade your production technology, in order to catch up with the rising East Asia.

The Inter-American Development Bank has just published a book on this very topic, titled  “The Emergence of China: Opportunities and Challenges for Latin America and the Caribbean”

The book is available for download (PDF file)

As food for thought, the book provides very detailed background information and insights. I am not happy with the answer of the book though, that the solution for Latin America is to serve China as a provider of energy, raw material, and commodities. You are turning Latin America into Africa (Nigeria, specifically)!

Brazil in the short term has reason to celebrate as it hits a jackpot as a result of China's hiking demand for iron ores, but don't forget that India is actually a bigger exporter of iron ores to China than Brazil currently is. If India can be an exporter of both raw material and high-tech services, why do you think Latin America should accept to be downgraded to a misery third-world exporters of commodity producer.

Hope this article can stimulate some discussions on how Latin America can cope with the rise of China and East Asia.

Richard Nixon used to advise then young Donald Rumsfeld : “Latin America does not matter.... no one gives one damn about Latin America!” Hope that’s not an accurate description of the reality.

Minimum wage, China vs India: is cheap labor the real answer for China’s success in manufacturing?

China has been said to be the World’s factory and cheap labor is said to be the reason why China attracts most of the manufacturing activities away from developed countries as well as from other developing countries.

Africa’s wage level is much lower than China, but they are never on the radar screen as threat to China’s position though. Nevertheless, let’s make a more relevant comparison between China and India.

India has a hard time in attracting manufacturing firms to move there. Many Indians attribute the “failure” to “that’s because we don’t have cheap labor; we focus on service industry with higher value-added”

Let’s compared the minimum wage of China and India to get a idea of who really has cheap labor.

Take China’s Guangdong province as an example. This province is where manufacturing activities agglomerate and where most immigrant workers from inland provinces are employed.

The hourly minimum wage in Guangdong province of China (Effectively July 2006- July 2007) :

Shenzhen (Special Economic Zone) and Guangzhou (two core cities, where manufacturing activities are moving out): 
4.66 Yuan/hour ( = 0.58 USD= 26.7 Rs.)

Shenzhen (outside SEZ), Foshan, Dongguan, Zhuhai, Huizhou, where most of the “sweat shops are actually located:
4.02 Yuan/Hour (=0.5