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Investor Beware: China's Growth Is Near Its Tipping Point
By Junheng Li
China's economic growth is not sustainable, warns Junheng Li, the "Tiger Woman on Wall Street." Above, one of China's main financial centers in Shenzhen. Photo courtesy of Daniel Berehulak/Getty Images.
Junheng Li, the "Tiger Woman on Wall Street," grew up a "tiger girl" in Shanghai. She recalls her dad drilling her on the multiplication tables when she was three. Hers was a primary and secondary education of memorization and regurgitation. But coming to the United States to study, first at Middlebury College and then at Columbia Business School, exposed her to a new way of learning that prioritized individual critical thinking.
From her years working on Wall Street, and now running her own equity research firm focusing on Chinese companies, she's seen that her early Chinese education is symptomatic of much larger structural issues that will soon plague China's economy -- and American investors.
Here Li explains to Business Desk readers why China's future won't be as economically rosy as its past. Her book, "Tiger Woman on Wall Street," goes on sale next week.
Junheng Li: When foreigners visit China, they are often impressed by the country's spectacular hardware: the modern architecture of the coastal areas, the fancy international hotels and luxury shopping malls, a high-speed railway that runs at more than 180 miles per hour, while providing passengers with Wi-Fi access.
The continuous news cycle that contrasts China's economic success with the lukewarm economic recovery in the U.S. and E.U. reinforces this view. A poll released in July by the Pew Research Center showed that many people around the world believe China is poised to take over from the U.S. as the world's next superpower. China's economic growth continues to chug along at more than 7.5 percent per year, with projections showing that it will pass the American economy by 2030. It seems to be merely a matter of time before China takes over the world.
But what is conveniently dismissed amidst popular American declinism is that China still lacks the "software" to support and sustain the impressive hardware. By software, I mean the rule of law, of accountability and good governance, and most importantly, the livable economic condition of China's people -- as citizens, workers and managers.
China's educational system has failed to produce either an honorable or an innovative labor force -- defined broadly to include all those who make their living by their hands or their brains.
Investing in a business is ultimately about investing in the people who run it. As a money manager and adviser, I often say to investors that a business is first and foremost about its executives -- its corporate leadership. Assessing the integrity and quality of management should be an investor's first priority when performing due diligence. Top managers are more important than the business model, market opportunities or anything else. If the manager is a crook or has serious character flaws, none of the other business factors will make the target a good investment.
Why the Status Quo Is Unsustainable
China's success is based on a single economic mode: mass production of low-value manufacturing products using abundant and cheap labor, massive capital investment and endless economies of scale. That growth prescription has lost its efficacy. The country's changing demographics make this system increasingly unsustainable, as China's aging population and rising wage costs eat away at the abundant supply of cheap labor.
The policy of accelerated urbanization, using carrots as well as sticks to cajole 200 million sometimes reluctant rural residents into the cities, will not reverse the trend of a rapidly rising cost structure. In fact, unheeded urbanization could turn into a costly economic, human and political failure. After all, China has yet to deliver equal rights to more than 200 million migrant workers in its cities. Rural citizens are denied access to many urban social services under China's restrictive hukou system of household registration under which services are only accessible to those with permanent urban residency status.
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In addition, the environmental degradation that is a byproduct of the country's capital-intensive, externality-ignoring development model is on view everywhere. Chinese citizens are seeing their life spans cut short by the poisonous air in the largest cities -- most pronounced in the capital Beijing -- the worsening water quality, and the polluted soil and food grown out of it. Indeed, while Chinese income per person has quadrupled since 1990, self-reported life satisfaction has actually declined.
The weakness of China's civil society, including the absence of free media, freedom of religion and freedom of speech, is another manifestation of how the lack of human and social capital hurts the quality of life and sustainable growth prospects. China's leaders increasingly view the formation of a vibrant civil society as a threat to the government -- a sort of insecurity on view in an ongoing crackdown on social media and the mid-September arrest of a Chinese businessman known for promoting civil society.
These measures suggest Chinese society is moving in the wrong direction, with negative implications for its economy. To upgrade and invigorate its current economic model, China has to adopt a more open, pluralistic political system. To transition to a more value-added, service-oriented economy, the country needs a society with a judicious mix of what Albert O. Hirschman, the great development economist, termed "exit, voice and loyalty": freedom of choice, freedom of expression and the ability to work together toward a common goal.
Last but definitely not least, China must overhaul its ultracompetitive education system, which continues to prioritize propaganda and memorization above independent and critical thinking. In sum, major changes, some of which will compromise the state's tight control over its citizens, are called for to produce a labor force compatible with the advancement of the economy.
Drawn to the American values of individualism, freedom and social mobility, I left China in 1996 to pursue a liberal arts education at Middlebury College in rural Vermont. In the years since, the overall structure of a Chinese education has remained effectively the same, despite the dramatic changes in the society and economy. Education remains first and foremost a device for drilling party ideology into impressionable minds. Material used in textbooks exemplifies and glorifies the party, showcasing how it takes care of its people the way a parent does for a child, and how society should therefore be appreciative and obedient, ready to put self-interest aside when the party asks.
Teaching ideology in itself is not necessarily a problem, but teaching the ideology of blind obedience surely is. American schools prioritize freedom of choice and individualism, encourage students to dare to be different, to think out of the box, to take risks, and to lead. The products of those ideologies include some of the world's greatest innovators, such as Bill Gates, Mark Zuckerberg and Steve Jobs.
To be fair, the Chinese system does have some merits, especially in knowledge-based teaching. But with China facing the challenge of transitioning to an entirely new economic system, it's no longer enough to churn out students who can repeat the right answers by rote; the country also needs people who can ask the right questions.
The Future Won't Mimic the Past
China today is essentially caught in a prison of its own past success, namely the staggering and unprecedented achievement of lifting 500 million people out of poverty in 30-plus years. Chinese people are energized and anxious at the same time. Outsiders are awed, and they assume past glory is indicative of future achievement. But the country's trajectory seems similar to that of an athlete on steroids whose temporary outperformance is likely to followed by a long period of underperformance.
To avoid this fate, China's singular focus in the past on fast growth and the purely quantitative bottom line ought to be shifted to the quality of economic growth, of the country's citizenry and of society. Wresting control from vested interests and carrying out the dramatic reform to institutions necessary to make this shift will be difficult, but it is the only way China can maintain its spectacular economic performance.
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Many transitional economies, including Japan in the 1960s and 1970s and Korea in the 1980s and early 1990s, have gone through a period of super growth and succeeded in advancing to a new model. A rich history of the developed world gives China an advantage: it can learn from other countries' history and avoid some of their mistakes, if it chooses to.
Within the country, a consensus is beginning to form, from the top leadership in Beijing to corporate executives to average citizens, that the country is nearing an inflection point that will force it to reflect and reform. Yet the vested interests who have enriched themselves on the country's old growth model have so far mostly succeeded in putting on the brakes. This conflict of interest should send a clear message to investors: buyer beware at this tipping point of China's growth. Assuming that the past rate of growth is the norm for the future may only invite costly mistakes.
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