The China-Killer

In 1853, Commodore Perry arrived in Japan with four black ships and a piece of paper. The piece of paper requested a treaty from Japan that (to make this short) cracked open the previously closed nation.
In 1875, a small flotilla of Japanese warships sailed close to the "Hermit Kingdom" of Korea on a "survey mission". Passing the fort of Kanghwa, Korean guns opened fire on the IJN Unyo,(trivia: in English, ship names are supposed to be italicised) to which the Unyo responded decisively. The port was silenced, the Unyo went on to obliterate another port, and in 1876 (to make this short), the Japanese forced the Koreans to open their borders.

Humans learn and imitate. Ideas are readily diffused from person to person and culture to culture. The Japanese learned from the West that to be strong, and to be considered part of the team, you had to open up other people's countries to foreign trade. All well and good. Then there was that thing about kicking other people's asses and making them produce raw materials for your industrial machine. It was called Imperialism, and it was in its dying days in the end of the 1800s and the beginning of the 1900s. That is equally to say it had reached its peak. Japan saw France, Prussia, England, and Russia beating concessions out of China. In 1894, they found their excuse to do so as well. While the Tripartite Intervention took away their land gains on the continent, it still won them an ally in England. This Imperialism thing didn't necessarily fizzle out with the Tripartite Intervention... Japan still had the opportunity to live up to its promise to England by containing Russian expansion in 1904-5, and this became a jumping off point for further expansion on the continent: Manchuria.

The problem was that, by 1937, Imperialism was becoming somewhat (to make this short) uncool. You could say this was because European nations suddenly realised that pounding other people into being their economic slaves was mean. You could also cynically say that the European nations had gotten all they wanted out of Imperialism and didn't want those Asian upstarts cutting into their fun. Either way, a bunch of Europeans and Americans decided the world needed to change paradigms. Out with Imperialism (it was too expensive after a while anyhow) and in with... I dunno. Something else. There was a war on, they didn't really have time to think about it. Rapidly after that war, the British Empire began to disappear. Colonial possessions were spun off into independence... to be swallowed up into one of two opposing sides in the Cold War.

This wasn't Imperialism... this was somewhat different. This was a war of ideas. Two really powerful countries each had their own really nifty idea. Each wanted the other to try it out. They wanted everybody to try it out. It was like Christmas. Either way you went, you got all kinds of presents. Side with one idea, and all of a sudden you got factories, aid, a secure oligarchic vice grip on power legitimised by political theory, vodka, and... secret military installations. Side with the other and you got factories, aid, a secure oligarchic vice grip on power legitimised by economic theory, bourbon, and... secret military installations. The nice thing about the factories in each case was that not only did you get them for free, the two nations who gave them to you wanted to buy your stuff and even sell you stuff at subsidised low prices!  Eventually, one of the ideas was more resilient than the other, and both big nations stopped buying a lot of that stuff from everybody, and stopped giving them aid and subsidising their sales as much. That sucked, just a little. We called it the development of a multipolar world. Multipolarity didn't last long. People don't like having to make up their own ideas about how to do stuff. They tend to take their cues from other people. Or other "isms".

I was trying to keep this short. I promise I'll get to the point eventually.

The issue was that the paradigm shifted again. The people who lagged in the paradigm were the people who were latecomers and ended up following the lead of one of the big guys. All of a sudden, all those dictators who had kept their countries - willingly or unwillingly - toeing the line of one or the other ideology, were uncool. They started to fall in rapid succession, starting from those who picked (or were picked by) the losing side in the Cold War: Najibullah, Jaruzelski, Kádár, Krenz, Husák, Zhivkov, Ceauşescu... the list goes on. But the winning side also began turning against its original groupies: Pinochet, Khan, Rhee, Marcos, and even finally Hussein. All of a sudden, it was more important to be democratic than aligned with a given idea. All the dictators who clung to power - now unsupported by the largesse of their selected big nation - slowly withered on the vine unless other revenues filled their coffers. As an aside, history has recently shown that even those dictators with secure sources of oil income are subject to forces of popular discontent.

From around  the year 1990 to now, we have been in a kind of realignment period. The USA has maintained the policy of (to make this short) currency supremacy through import. As long as the US buys enough stuff, specifically oil, the world will have to buy oil in American dollars. The European Union has tried to maintain a strong unitary currency, but also constructed a Byzantine legal environment that, oddly enough, produces a grand variety of industries (and protects indigenous ones). China has made money by producing a lot of stuff cheaply and quickly. It is assisted in this by pegging the Yuan to the American dollar. While this means the cost of raw materials is relatively high for the Chinese, they can make their margins in the economy of scale and the relatively low pay of their workers. This necessitates inputs that can not be reliably found in China: R&D, technological innovation, and management expertise.

Yes yes yes, China has some managers and some engineers and some scientists. They do some neat stuff. Typically they do neat stuff that makes things cheaper, not better. That's how you do better in business in China. You make something cheaper than the other guy. I know, I live here. Best Buy just pulled out of China. To quote the article, "Mao Xinlie, 78, said he will miss Best Buy's reliability. "The good thing about Best Buy is the quality of stuff they sell, but their prices for products and services are higher," said Mao outside the retailer's store in Xujiahui". Quality doesn't get you sales in China, price does. Best Buy's business model is service-oriented. Service does not get you sales in China, price does. Best Buy's competitor, oddly enough sporting a dark-text-on-yellow bold logo, is local, and competes where it counts here. Price. The corollary: when the nouveau riche throw their money around, they don't care about quality - they simply want to buy lots of high-priced stuff. It's not about quality. It's about showing your wealth off, and you can't do that unless you blow it on stuff, no matter how crappy that stuff is.

So price is the motivator, so that means the market privileges items that offer the same basic services as innovative products (like, say, the iPhone) cheaper. It makes sense that if a product is successful, it gets reverse-engineered and built cheaper. So yes, there are engineers and scientists here. The price signals tell them to build it cheaper and sell a lot, not to build it cooler. The three things this market niche depends on is stable prices for industrial inputs, a low currency value, and low salaries. These things are pretty much the three legs of the Chinese economic stool. The problem is that these things are being disrupted.

Raw materials prices are going up. Copper $3.50 to $4.50 USD/lb in the past six months. Nickel: $10.00 to $13.00 USD/lb in the past 6 months. In addition, China is a net food importer now and has just suffered a drought in Yunnan and may lose a large portion of its wheat crop this harvest season. Food prices are skyrocketing - I can tell you that first hand. China has always tried to engage primary resource producers to sell in large quantities at substantially reduced prices in order to fuel its economic machine... but spot prices are making this an uneconomical way of doing business for the producers. The demand is still there, and selling to the market is more profitable. This is why China has an aggressive development strategy around the world, especially notable in Africa: to get access to those desperately needed raw materials at fixed (or near fixed) prices. Those prices will not last for long.

Raising costs for things such as food are also a problem. After the Economic meltdown in the end of 2008, China basically shut down huge portions of its manufacturing industry and let the migrant labourers who work in factories simply go home. When work picked up again, many labourers were not keen to go back for the same price. Food has been creeping up in value, and workers wanted better conditions. Interestingly, they are sometimes getting them. Labour unions (which have miraculously started by restricting themselves only to petitioning foreign companies and nobody else - I wonder how that happened) have started to form. Labour costs are going up, and workers will be demanding more with the increase in food costs. Two of the legs of our hypothetical stool are therefore a bit wobbly.

The last is currency value. This is a bit of a damned-if-you-do, damned-if-you-don't problem. With so much foreign pressure on China to float its currency, no Chinese leader can do so without being perceived as weak-kneed in the face of Western Imperialism. If China doesn't float its currency, it may be priced out of the raw materials market. More importantly, now that it is importing a good deal of its food, it will be priced out of the food market, too. Chinese food production is in a downward trend with more and more land producing less and less food. Imports are not a temporary glitch, imports are here to stay for China. With high food prices comes the need to raise salaries or face food riots. Riots are already becoming commonplace in the countryside (it's just not reported that much). They are called "mass incidents" by the government and they are rising in frequency. This isn't to say China will be toppled by a bunch of mass incidents. It may, but that isn't what I'm talking about at all. The mass incidents are simply an index of discontent. If China does float its currency, all bets are off. "Central planning" goes to the whim of the currency markets. If the Yuan rises, exports halt, the low salary bonanza ends, and all of a sudden China has to develop a completely different type of industry simply to survive. End of story.

All this to say that China is in a precarious position right now. It is going into a period of stagflation, the growth of the economy is financed by very bad debts, two of the legs of the Chinese economy's stool are starting to get wobbly, and the last one can't be cut to measure accurately enough to counterbalance these forces. This doesn't make the position of the USA or Europe any more rosy. Each of these paradigms are feeling stresses. So what would push one to the forefront and leave the others in the dust? A paradigm shift.

North America, the US in particular, is really good at coming up with crafty ideas, fun ideas, interesting ideas. These ideas get financed, then sent to China to manufacture. The thing is, the North American market is rather diverse even though less populous than China. It actually doesn't obsess about price as much as service. Do you think to yourself "I want an air conditioner from GE" or do you think "I want this room to be cooler right now"? Do you think "I want a brita water filter", or do you think "I want fresh water to drink"? Our so-called obsession with stuff is actually not so much an obsession... we buy stuff to fulfill a need, and then when it breaks, we buy a new one. It's cheap, we end up focusing on the stuff and not the service. But if someone came up to you and said "I can make your house the temperature you want for $700 per year, no cost for repairs or replacement of the equipment", would you be tempted? The market in North America could easily become one of services.

The purchase of services would create a demand for quality over quantity. Service providers that use machines to provide their services would go for the best value over the amortisable life of the machine. The longer that life, the bigger their margin. The better the spare parts services and distribution, the bigger their margin. Economies of scale start to lose traction.

But there's more. Rapid prototyping and 3D printers and fab labs would make spare parts even more available, especially if designs were provided to decentralised manufacturers over the web. With local CNC operators and manufacturers turning out spare parts, there is no transport of huge masses of bits to nodal points for further distribution down the logistical chain. A design company makes an air conditioner design. They can test it by firing off designs to CNC millers and fab labs in their region to prototype it. When they have a working model, they put the design online and license its parts on a per-click royalty system - kinda like a printer service contract. Individual millers and fab labbers could make money off other people's designs, and kick back a small percentage to the designer. Local manufacturing that was nimble as opposed to efficient would win the day. Economies of scale be damned - in this model, local economies, durability, and innovative design win.

So, that was a really long story. To sum up: the leader wins in a paradigm shift. If North America switched to a service economy, decentralised manufacture, and paid designers their due, economies of scale would be relegated to the compost heap of economic history. That paradigm shift would be the China Killer, and China imperils itself every day by not developing indigenous high-tech industry that focuses on product and not on price.