Morningstar Advisor - December/January 2012 - (Page 55)

is hardly supportable. There was a book titled Finance in China published in 1913 in Shanghai, just before the First World War and right after the end of the Qing Dynasty in China. It predicted that China would take over the West, because China had a much larger population than all the Western countries combined and because labor was much cheaper than it was in the West. Then, with the same aptitude for imitation that the Chinese population was known for at that time, media commentators and economists made the same prediction—that pretty soon after 1913, China would take over the West. But, of course, after 1913, we know what happened: the First World War, then China was invaded by Japan, the Second World War, the civil war in China that went on for many years, and then the Cultural Revolution. I’m not saying that this time the prediction will be proved totally wrong. Instead, what I’m saying is that first of all, we cannot linearly extrapolate the past 30 years of economic growth into the next 30 or 50 years. The past 30 years of growth has taken place because of some historical reasons, but those historical reasons will not necessarily give China another 30 years of growth. I think the next 30 years may look more like the following. Within the next five to 10 years, there will be some significant financial/ economic crisis that will set Chinese economic growth back. The total size of the Chinese economy will be dented. But that will set the stage for major institutional, political, and privatization reforms, and such reforms are really necessary to prepare China for another two decades of steady, but not as fast, growth rates. So, it may take until 2027–28 for the Chinese economy to exceed the U.S. economy based on purchasing power parity. But in nominal terms, it may have to wait until 2049–50 for China really to catch up with the United States in terms of economic size. Unless there are major revolutions in China, it will be inevitable that the size of the Chinese economy will exceed the U.S. economy. The reason is not based on the past 30 years of growth experience in China. Rather, it’s the very long-term trend of correlation between population size and GDP size. In the 17th century, roughly speaking, there was a 98% to 99% correlation between a country’s population size and economic size. By 1820, the correlation was still high at 97%. But by 1870, roughly one century after the Industrial Revolution started in England, the correlation dropped to 83%. In 1950, the correlation dropped to 39%, and during the peak of the Cold War period, 1970–73, the correlation between population size and economic size reached a bottom of about 35%. But in the late 1970s, China started opening up and conducting reforms, and then pretty soon after that, in the 1980s, many countries all around the world started privatization and reforms and so on. As a result, the correlation between population size and economic size reversed its direction. It’s now about 62%. This trend will probably continue, so that large countries like China and India, both of which have more than 1.3 billion people, will benefit. For this reason, unless China would really mess it up, its economy will exceed the U.S.’. This long-term historical trend is not likely to change. There are many reasons behind the rise in correlation between population size and economic size. Let me focus on two macro reasons. The first is the industrial revolution or industrialization. After more than two centuries of development, industrial technologies for production have become so mature and mobile that any country that has a large enough labor force and low enough cost of labor can now get into manufacturing pretty much overnight. Today, it’s no longer just China, but also Vietnam, Cambodia, and many other more-underdeveloped countries. If they really want to, they can attract investment and set up factories within a few months and engage in exportoriented production. But this was not possible going back to the 19th century, when industrial technologies were just starting to emerge and progress. In those days, the innovator countries would first have to benefit from the newly emerging and developing technologies. Also the technologies were not easily movable across borders. The more populous traditional societies, like the Indias and Chinas, could not take over manufacturing so fast because of the training and sophistication requirements that were needed. But today, everything is so mobile, so mature. You can engage in manufacturing overnight. I’m saying this partly because historically for researchers and scholars, we have to face the following question. China over the past 30 years has been able to develop the economy so fast, when the Chinese population is just about 20% of the global population. But in 1900, China had about one third of the world’s population. How come China was not able to take advantage of its large and cheap population then? Something else must have been going on. Of course, some people may say, “Well, Chinese people today work hard and they are more capable, they’re smarter, whereas 100 years ago the Chinese were not as laborious or diligent or smart.” I don’t think this is the case because I’m pretty sure 100 years ago the Chinese people were probably even more willing to work hard than they are today. So, a simple willingness to work hard and abundant cheap labor are not the key causes for China’s economic growth over the past 30 years. Rather, it is because by 1978, the maturity, quantity, and quality of industrial technologies reached such a level that China only needed to say, “Now, our policy is both to reform the economy and let the MorningstarAdvisor.com 55 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - December/January 2012

Morningstar Advisor - December/January 2012
Contents
Contributors
Letter From the Editor
Seduced by Complexity
Is China Exposure Important for a Portfolio?
A Niche Built on Trust
How to Find Your Client’s Investment Style
Taking the Long View
Consensus on Europe Elusive
Four Picks for the Present
Investment Briefs
Is Perception Reality for Active Managers?
Be Alert for Basic-Materials Bargains
Investment Boom Unsustainable
Digging Moats in China
Where China’s Domestic Companies Stand to Benefit
Arising Opportunities
China Strong Long Term
From Currency Manipulation to International Acceptance
The Keys to China’s Fortune
Wedgewood’s Lessons Pay Off
Reading the Evidence on Indexing
Scouting for Investments Abroad
Yield, Please (Hold the Europe)
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
China Fund Managers Eat Elsewhere

Morningstar Advisor - December/January 2012