Morningstar Advisor - December/January 2012 - (Page 56)

Morningstar Conversation market forces have their way, to open the door to foreign direct investment and to international trade.” The second major reason for the past 30 years of fast economic growth in China has to do with the international order for trade and many other things, political and otherwise. One simple way to differentiate today’s global order from the global order of the 19th century, or even as of 1913, is that today’s global order is rulesbased. The 19th century global order was gunboat-based. Having a rules-based world order is dramatically important for countries like China and India. Compare the biggest English multinational corporation in history with today’s biggest U.S. multinational corporation, the East India Company of the 19th century England versus the General Electric of today. For most of the 18th and 19th centuries, the East India Company maintained its own navy and army. In fact, for most of those years, the East India Company’s navy was much bigger than the Royal Navy, and the East India Company’s army, mostly based in India, was bigger than the English Royal Army. Why was that necessary? Well, when the international order for trade and cross-border investment was based on gunboats, on raw power, you had to protect your overseas investments and traders. You had to spend a lot of money to make sure that your navy and army forces were powerful. To make China the world’s factory, China would have had to first expand and develop its own navy and military forces, which would have taken many decades if ever possible. Of course, today, General Electric does not have any military personnel to support. Neither does GE have to buy its own navy ships or pay for weapon supplies. Rather, GE has maybe a few thousand full-time lawyers to help it stage global business transactions. But GE’s cost of doing international investment and international trade is many orders of magnitude lower than the costs that the East India Company and Western European countries had to pay. So, this globalization trend will continue to make countries with large and cheap labor forces able to take over global manufacturing and grow their GDP as a result. on developed countries to provide markets for the excess production capacity in China. Let me just give you some statistics. If I divide the total fixed capital investment in China each year by the per-capital disposable income for the urban population in China, then in such relative terms, back in 1980, the total fixed investment of the Chinese economy was roughly equivalent to 200 million urban residents’ annual disposable incomes. By 2009, the total fixed investment in China was equal to 1.3 billion urban residents’ disposable incomes. Of course, China does not have 1.3 billion urban residents. It has at most 700 million or so. This shows that this totally investment-driven economic growth model, the exports-oriented growth model, can no longer continue. As many others have commented, a major restructuring of the economic growth model is really needed. From what I can see, the major restructuring would have to include, first off, all the privatization of the remaining state-owned assets and publicly owned land—because otherwise, private citizens and households would not be able to participate in the wealth effect of economic growth. When households cannot participate in the wealth effect from economic growth, they will not be able to consume much. If they cannot consume much, then the Chinese economy will continue to have to depend on investment, and then as a result of that, it will have to depend on exports. But we know that investment dependence and export dependence are no longer sustainable. Nonetheless, the GDP growth rate is still going to be about 9% this year, and very likely it will be about 9% next year as well. Such GDP growth rates will not incentivize the policymakers to undertake any major structural reforms. This human behavioral bias will be the reason that within the next five to 10 years the Chinese economy will unavoidably go through some major crisis, period. Looming Crisis Peng Chen: You mentioned that in the next five to 10 years you expect a crisis to occur in China. China’s economy is growing by around 9% this year—still very strong despite weakness across the world. If you look at what makes up China’s economy, around 30% is in consumption, 40% is from the investment, and the other 30% is from exports. Over the past few years, the investment portion has grown quite a bit compared with what it was before the global financial crisis. I was just reading Time magazine, and the cover article was about a bubble in China, particularly in the real estate sector. What are the imbalances that you think could trigger a financial and economic crisis? Zhiwu Chen: The Chinese economy will be the victim of its past success, in the sense that too many policymakers, economists, and people in the business community in China are very happy and very satisfied and very proud of the past 30 years of economic growth. Their old economic growth model has worked so well that they are not going to have any incentive to change or restructure it. Investment has been by far the most important driver of the past 30 years of economic growth. Exports for at least 20 years have also been an important driver of economic growth. But China hasn’t realized that the manufacturing-plus-WTO-dividend is more or less used up. The recent financial crisis has made it more difficult for China to continue to rely 56 Morningstar Advisor December/January 2012

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

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