Silly Rumor #1: How China fixed socialism

I’m reluctant to begin any conversation with a sports metaphor, but I took Monday night off to watch the undefeated New Orleans Saints dismantle the once mighty New England Patriots and the one-sided spectacle is stuck in my mind. What happened to reverse the fortunes of these two organizations in so short a time? Had someone finally solved Coach Belichick’s schemes? Had the veteran players lost their edge? Were the rookies just not as good? Was the opposition more driven to prove themselves against an established foe? Was it due to all of these, or to something else entirely? Whatever the cause, the weak were now strong and the strong had fallen.

How the world has changed. China is now the world’s banker of last resort and the U.S. is perilously close to financial ruin. Communist China, whose modest reforms hit a wall twenty years ago in Tiananmen Square, has now beaten America at our own global industrial game. The Russians couldn't do it, failing year after year to forecast demand, produce efficiently or compensate workers. Neither could the Cubans, North Koreans or Vietnamese, but with limited resources and small populations they never really had a chance to dominate a global stage. Ironically, while the Ministry of International Trade and Industry steered its economy, many referred to Japan as the only communist country that worked. Japan’s greatest strength continues to be its legendary productivity, but declining birth rates have left the world’s second largest economy shackled with an aging population, slow growth, labor shortages and, most recently, price deflation.

So how did those inscrutable Chinese manage to make communism work? It's not because they're better producers; China isn’t nearly as efficient as the U.S. (Chinese industry is dreadfully unproductive compared to Japan.) However, China followed the familiar Asian formula and stoked exports while protecting nascent industries in its blossoming domestic market. Learning from the folly of Soviet –style central planning, China recognized that free markets are better at determining what to produce and when, but are also vulnerable to predatory pricing (a.k.a. dumping) from low-cost suppliers. So Beijing gradually granted equity in industrial firms, with lax regulations, leveraged its authoritarian control to hold down wages and exchange rates, and introduced reforms to entice foreign investment and foster domestic entrepreneurs. The Chinese people quickly embraced the new opportunities, forming joint ventures with western firms to access cash, technology and managerial capability. When wages began to rise, Beijing intervened to prevent the yuan from appreciating against the dollar. Many Chinese firms simply ignored patents and copyrights, instead saturating markets with “knock-off” products while saving untold millions in R&D costs. Even with these tactics in place, China benefitted tremendously when President Clinton finally granted them permanent, normal trade status with the U.S. in 2000.

The results were staggering. Most domestic manufacturers came under intense cost pressure from Chinese competitors, eventually yielding market share or succumbing altogether. Many firms like high-end Quaker Fabric of Fall River, Massachusetts, that had used innovation, design and technology to survive earlier upheavals, were unable to compete and closed their doors. Many other American companies, reading the writing on the wall, moved production to China to remain cost competitive while hoping for eventual access to the growing Chinese consumer market. Previously vibrant industries were gutted or lost entirely as capital, capacity and intellectual property surges offshore.

As U.S. consumers spend more dollars goes on Chinese-made goods, China accumulates more and more cash. The spectacular 2008 Summer Olympics was merely a coming-out party. Beijing has used their new wealth to improve its domestic infrastructure and modernize its military. They are acquiring exclusive control to raw materials and sea lanes around the globe. They are increasingly humanitarian and are building a space program. To head off dissent among the Chinese people, Beijing has slowly improved their standard of living while promoting China’s growing prominence on the world stage.

In short, China is becoming a superpower.

China’s strategy is obviously working. Whether their ascendance is sustainable isn’t as clear. I see two factors that might determine this outcome. First, China’s strategy relies on a continuous gradual improvement in domestic living standards to forestall currency appreciation and human rights protests, at least until the Chinese market can supplant the export economy. This is a catch-22 for Beijing; they must eventually create a domestic market, but even with its enormous new wealth the Chinese domestic market is still too small to pull untold millions more Chinese up from poverty.

China needs someone to buy their exports, but in the aftermath of a global recession the United States and other foreign markets may not have the money or willingness to continue cooperating with China’s export-driven ambitions. U.S.-China trade can’t remain so terribly unbalanced for much longer without bankrupting America, and even now the recession and weakening dollar should inflate the price of Chinese goods and dampen American demand. If Beijing ignores these problems and kills its golden goose, it may find the remaining wealthy nations of Europe and Asia more protective of their domestic economies. That will slow China’s growth and potentially create domestic problems.

Second, a destitute population is easily pacified with small blessings, but an affluent and educated Chinese people will almost certainly demand far greater social and political reforms than Beijing has so far proffered. China's communist leadership will face greater difficulty maintaining control of their new industrialists and middle class. Likewise, centrally managing the economy will become far more complicated as the needs and expectations of Chinese citizens grow. Whatever else happens, it’s likely that the Chinese people will eventually gain sufficient wealth to support their own economy. Communism may have helped make a workers' paradise of China, but it doesn't do so well when the proletariat make real money. That's usually when democracy steps in.

Beijing’s success may be its undoing.

First, a "Hello" is in order

My family will tell you that Thanksgiving is my favorite holiday. Not only do we celebrate a uniquely American tradition, but it allows us to express our gratitude and optimism for the bounty of the world. Even in this troubled time, I am grateful for the blessings of my family, my community and my business.

So who am I, and why should you care? I am Jack Kahler. I have a lovely wife and two fine sons. I am president of Avocus Group, an operations consulting and training firm based in Illinois, and I also serve on a school board.

I tend to talk a lot, so this is probably as good a time as any to begin publishing my thoughts about business, society and the economy. Some of my acquaintances would surely appreciate any reduction in my outspokenness that might result from this alternative form of expression.

Finally, let me warn you that I don't anticipate running for another public office, so my comments here might offend any readers who must resort to political correctness as a haven from reason. We can all learn something from dialog so your feedback is welcome. I won't censor you unless you're especially vulgar or offensive; in that case I might invite you to join me for drinks.