Current Events

Chinese Trade Talks

There is growing concern that the US will find its way into a trade war with China. The US government announced tariffs on steel, aluminum, and possibly on other products as well. China has announced their “Made in China 2025” a plan by which Chinese leaders intend China to be the leading nation in robotics, biotechnology, etc.

China was an agricultural society less than 50 years ago. Today they are the second-largest economy, behind only the United States. They are on a path that could make them the largest economy in the world, and surpassing the United States. How did that happen in such a short time?

If you have been reading my eletters or my blog or listening to me on the radio you know I believe history does not repeat but it rhymes. France had a similar path to China’s in the 17th Century.

In 1661, Louis XIV acceded to the French throne. France was essentially bankrupt, having fought three major- and two minor wars. In those times there was no paper money; money was specie – gold and silver. Unfortunately, France had no gold or silver mines. So in 1665, Louis XIV picked Jean Baptiste Colbert as his Treasury Secretary and put him in charge of growing France’s economy.

French industry consisted mainly of small craft shops, which were not internationally desirable and kept France poor and secluded. What Colbert realized was France needed industries, and he set about making that happen. First came “Royal Privilege,” wherein foreign businessmen could set up government-financed factories in France without being charged taxes. The Government also guaranteed that they would purchase the full output of the plants. Glass and textile factories were built – and some of those companies still exist today. They were to have the best quality in the world. The products were sold both in France and exported to bring in much-needed gold and silver. Competing products from other countries were not allowed into France, so French companies easily succeeded.

Colbert sent spies to England and other countries to steal the secrets of behind their manufactured products and steal the technology. From other countries he recruited craftsmen and entrepreneurs, and once in France they were not allowed to leave. Over 15,000 craftsmen were executed when they tried to return to their home countries. Factories employed over 1,000 workers, something new in France. The workers were paid a minimum wage and worked 14-16 hours a day. The only days off were religious holidays and Colbert lobbied the Catholic Church to reduce the number of religious holidays, believing there were too many. Colbert encouraged women to marry before twenty so they would add to the workforce. Workers were housed in dormitories to be close to work.

Colbert formed a corps of state-funded industrial inspectors who were charged with ensuring products were of the highest quality. Failure to meet these high standards was punished with a stint rowing the King’s galleon.

The Dutch had dominated international trade when Colbert arrived. He constructed a commercial navy to compete. Ships from other countries calling at French ports paid excessively high duties on the goods they delivered.

France became renowned for producing the highest quality products, especially luxury goods. Companies like St. Gobain and Gobelin Tapestries maintain that tradition today.

Jean-Baptist Colbert? He was hated both by the French and by foreign governments, but he launched France into the path of large scale industrialization. He made them an economic power with a technique called Mercantilism.

This is almost the same path China has followed. The Chinese government decided on industries they felt would be key to growth and poured their resources into them. The government owns the banks, and is thereby providing all the country’s financing. The government controls the building permits and determines what and where factories will be built. For example, TAECO is a joint venture between Chinese companies and some airplane manufacturers, including Boeing. TAECO was set up to convert Boeing 747s from a passenger configuration to freighter configuration. That is a common evolution for older aircraft. TAECO hangers and facilities were built on what was once a large duck preserve.  The government owned the property and there was no urban planning, just orders to build. The technology was furnished by Boeing. I believe at one point there were over 15,000 workers, and all were housed in dormitories.

It all sounds like France under Colbert, doesn’t it? The government owns the land. The government controls the banks. The government decides on infrastructure. The government forces joint venture partners to share or give away their technology. The government limits competition and the government guarantees purchase on the products produced. They control building and prioritize what is built and where.

70% of Chinese exports are from factories that were relocated from overseas. For example, several years ago FOXXCOM, a Chinese company, employed 300,000 low-paid laborers housed in dormitories. 100,000 of those workers were dedicated to producing Apple products like the iPhone and iPad which would be exported back to the United States. The other 200,000 were working on Hewlett Packard and other high tech company products.

That is why China has evolved from a backward agricultural country to the second largest economy in the world.

What’s more, China has not played fair. In 2001, they joined the World Trade Organization (WTO) as a developing nation1 with many of the provisions designed to help developing nations grow. For example, tariffs on cars are 25% for cars shipped into China, compared to Chinese cars imported into the US at 2.5%. China is now the second largest economy in the world, but still has not changed their status with the WTO.

However good that sounds, it also seems like the economy is built on sand foundations rather than concrete. From what I read, many of the big industries are not efficient. They are funded and supported by the government, and there is little incentive for them to be efficient. TAECO for example was operating at a significantly reduced rate a few years ago. How much of that was due to a slower economy and how much to inefficiency, I don’t know.  But I could say inefficiency certainly contributed.

We know in this country there are certain functions the government should have, but when the government becomes involved in the private sector it seems to be inefficient and ineffective. I believe we are seeing that with China.

This year at the five year summit, Xi Jinping, the supreme Chinese ruler, announced the “Made in China 2025” plan. The goal of the plan is to make China the leader in the industries of the future. The plan calls for Chinese companies to produce for Chinese consumption. The target is to produce 80% of electric cars, 70% of industrial robotics, 70% of medical devices, 60% of targeted tractors, and 10% of aircraft in China2. If they are successful, they could and would displace most of what the United States exports to China. Instead of reducing the trade balance it would reduce US exports to China by some 85% to 90% while maintaining or growing Chinese exports to the US.

My guess is trade talks with China will not persuade them to back away from “Made in China 2025”. They feel they can outlast the United States in a trade war. I would also guess China will make great strides in those targeted industries. They will be strong competitors in the short-term with government financial support whether efficient or inefficient. The US will have no leverage since they will be producing for China.

If and when they achieve “Made in China 2025,” they will be exporting their products in these categories to the rest of the world in direct competition to the US and remainder of the world.

I believe we have little leverage in trade talks with China. Further to that I do not believe they will play fairly and honestly.

Abraham Lincoln asked this question: “if you call a dog’s tail a ‘leg’ does the dog have 5 legs?” No, the dog has only 4 legs. Calling the tail a ‘leg” does not make it a leg.

It will be important to follow and understand what is happening in China. There will be pundits who will bemoan their entry into those key industries and will shudder when they make some breakthroughs. But I believe just their entry and a few breakthroughs will not put them on a path to long-term dominance of those industries. Just because they say they are going to dominate does not mean they will, no more than calling the tail of a dog a “leg”. But it will impact some US companies and in my opinion it is prudent to be very cautious in investing in those companies.

Notes:
1.    “Some Things Are True Even If Trump Believes Them” – column by Thomas Friedman, NY Times, March 13, 2018
2.     “The People’s Republic of Protectionism”, Barrons, May 4, 2018

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