China: The Urgent Need for Speed…

China: The Urgent Need for Speed…

by Vikram Mansharamani, PhD

Recent social unrest in the Middle East has spurred speculation that similar uprisings may take place in China. Is there any reason to believe that social instability (or revolution) is possible in China? While the immediate threat of an uprising in China appears limited due to the government’s iron grip on media and communications, China faces very different dynamics than those that have recently struck Middle Eastern countries. In particular, the source of legitimacy for the Chinese authorities over the past 20+ years has been economic opportunity. At least historically, such an implicit social contract was not the basis of the regimes in the Middle East. By creating jobs and the potential for a better life, Beijing has dampened desires for political reform or representative government.

Unfortunately for Beijing, signs of increasingly difficult and less-hospitable economic conditions are increasingly apparent to the ordinary citizen. Increasingly unaffordable housing. Rampant food price inflation. Inadequate employment opportunities. Rising inequality. Forced relocations. Environmental pollution. Widespread corruption. While each of these is by itself enough to generate resentment among a populace, the combination of these factors creates explosive potential for social unrest and possibly even (gasp!) revolution. It should come as no surprise that Chinese leaders – facing this potentially lethal cocktail of issues – are concerned.

The stakes are high, and not just for Beijing. China continues to be one of the world’s fastest growing economies and has had a tremendous impact the global economy. Its voracious appetite for commodities has generated growth throughout the global commodity complex, and many industrial markets continue to be driven by Chinese demand. Any disruption to the Chinese development story will surely have global ramifications.

Author and money manager Vitaliy Katsenelson has analogized the Chinese economy to the movie Speed, in which the bus must maintain a certain speed or an onboard bomb will detonate. There seems to be good reason for such an analogy. Consider the recent boom in education. In 1998, China had less than 1 million students graduating from college each year. Estimates today suggest that number may be close to 7 million, and rising. Despite healthy economic growth, the pace at which new white-collar, professional jobs are created has not kept pace with the surge in college graduates. Between 2002 and 2009, wages for college graduates remained essentially flat (negative if you consider inflation). During the same time, unskilled laborer had their wages rise by more than 80%. In a cruel twist of fate, it seems Beijing’s spectacular accomplishment in education may threaten the regime’s very foundation.

Aside from a mismatch between the supply and demand of college-educated workers, the problem is exacerbated by the inflexibility of the typical Chinese curriculum. In most cases, students tend to spend their college years developing expertise in a particular subject (engineering, computer science, accounting, etc.) by focusing almost exclusively on the topic for four years. As a result, students lack the flexibility to adapt to China’s changing labor markets. The mismatch is likely to get worse as China migrates from an agricultural economy to a manufacturing economy and eventually on to a services economy.

Deng Xiaoping’s declaration “to be rich is glorious” unleashed significant entrepreneurial energy; what China needs today is a similar battle cry for a more flexible education policy. Labor markets for skilled and educated workers need to become more dynamic, and one way to do so is to encourage the Western model of liberal arts education. Yale University President Richard Levin has noted that the most important characteristic of a well-educated person “is not subject-specific knowledge, but rather the ability to assimilate new information and solve problems.” Education reform is needed…and soon.

The clock is ticking. China today exhibits many of the tell-tale signs of a great speculative mania. Higher prices in many of its asset markets are generating demand more rapidly than supply. The cost of money is inappropriately cheap, driving mal-investment and creating overcapacity. Confidence is bubbly, with skyscrapers rising, art markets booming, and conspicuous consumption galloping forward. Moral hazard runs rampant, and national-provincial dynamics are generating GDP growth through unnecessary and low ROI activity. Finally, amateur investors seem ubiquitous, and the largest developers today are state-owned enterprises using money from state-owned banks to buy land from the state.

All of these indicators point to the fact that the Chinese economic bus is running low on fuel. A financial bust or even economic slowdown may just detonate the onboard bomb, resulting not only in an elevated risk of social unrest or possible revolution within China, but also a meaningful slowdown in global economic growth.

Vikram Mansharamani is the author of Boombustology: Spotting Financial Bubble Before They Burst, published by John Wiley & Sons. The book presents a multi-disciplinary method for identifying unsustainable booms in financial markets.