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From WSJDN
China’s Lessons From Mexico and Japan
Is China the next Japan or the next Mexico?
One worry for investors is that China will go the same way as its Asian rival. Like Japan once did, China is playing a game of rapid catch-up with the U.S., with growth in output driven by high investment and exports. As also occurred in Japan, that model has led to the buildup of stress points in the domestic economy: a bubble in the real-estate sector and bad loans in the banks.
The crucial difference is the level of development. Taking 1990 as the date when Japan’s growth faltered, gross domestic product per capita, in purchasing-power-parity terms, had already reached more than 90% of the U.S. level. Capacity to grow by catching up was all but exhausted. The real-estate bubble burst when Japan’s urbanization rate was over 60%. In an already predominantly urban society, fundamental demand wasn’t strong enough to pick up the pieces.
In 2009, China’s GDP per capita was 18% of that in the U.S., and the urbanization rate had not yet touched 50%. The contrast is clear.
Significant scope to grow by catching up to the world economic leader remains. If the ghost towns that loom large in the bear case against China are a genuine problem, continued urbanization means fundamental demand should allow China to grow through it at some point. A Japan-style lost decade doesn’t appear to be in China’s immediate future.
A more realistic threat is that China is the next Mexico. Mexico grew through exporting low-value-added goods to the U.S, without paying too much attention to improving human capital and developing an efficient financial system. As lower-cost competitors entered the world economy, a weak education system and inefficient allocation of capital started to constrain growth. China took export share and growth stalled. Mexico’s GDP per capita languishes at 28% of that of the U.S., a lower level than in the early 1980s.
Here, China might have more to worry about. Wages in the low-skill manufacturing sector are rising fast. On their current trajectory, they will double over five years. Low-skill jobs will continue to migrate elsewhere. Public spending on education, at 3% of GDP in 2009, compares unfavorably to an average of 5% in the grouping of upper-middle-income countries to which China aspires. Reform of the financial system has fallen by the wayside as banks continue to funnel savings to low-yielding state-sponsored projects.
Of course, China’s record of economic management is much stronger than Mexico’s. And the government articulates the importance of reform. But words have so far not been matched by action. In August, a move to bulldoze schools educating children of migrant workers in Beijing seemed emblematic of policy makers’ priorities. With education key to avoiding the middle-income trap, bulldozed schools, rather than ghost towns are the bigger threat to development.
