Who's Afraid of China?

The Chinese have been able to price their products so cheaply, in large part, because of currency controls and export rebates. What has looked like a competitive edge is actually a distortion in the market.
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We are, and so are the Japanese. But for all the wrong reasons. Today's New York Times tells a story of how China's economy will soon overtake Japan's -- and by implication ours. It ends with a peal of doom: "China," says a Japanese think tanker, "is about to leave everyone behind in a big way."

Except it won't. Remember the exploding tires? The blood thinner that killed Americans as they lay in their hospital beds? The infant formula that sickened and killed thousands and thousands of Chinese infants? These are not exceptions to the rule. These are not a few bad apples. This is business as usual in China. It's risky to make things there. Risky and expensive.

You need to go to the factory floor to see why. By the time you get your raw materials, whether chemicals or plastics or milk solids or whatever, they've passed through several middlemen. You, in turn, must farm out some of your work to smaller firms to handle parts of the job that you can't. All the players in China's labyrinthine supply chain that touch the goods add risk. And cost.

Until now, the Chinese have been able to price their products so cheaply, in large part, because of currency controls and export rebates. So what has looked like a whopping competitive edge to us is actually a distortion in the market. Don't be fooled. If China struggles to make drugs, food, and engineered goods safely and reliably, not only is China not about to overtake us, but in biting off more than it can chew, China is rashly exposing its companies and the Made In China brand to a lot of risk.

Before it can become a true manufacturing juggernaut, and not just a giant assembler of imported components, China has lots of work to do. Work that I think will take generations. China must rationalize its sprawling supply chains, acculturate its workforce to quality, change the very way its corporations are governed and its laws enforced. This is not going to happen anytime soon.

Meanwhile, China needs modern goods and services to keep its economy -- and middle class -- growing. Modern hospitals and airports, infrastructure and power grids. The Chinese can fabricate a lot of this stuff -- that is, put together the parts. But in terms of making the stuff themselves, especially the goods that require a high degree of engineering and safety, China bucks up against the limits of its own capability and must import. From countries like America and Japan and Germany. That's why, despite our economic doldrums, our exports to China keep rising. China needs what we make.

We can take some heart that Japan's plan, according to the NYT, is to shy away from exports and focus on goosing internal consumption...from its aging, shrinking population. Good luck with that. Meanwhile, China's huge, modern, urban middle class will keep growing, and its imports of modern goods and services will, too. That's wonderful news in this recession. China's demand plays right into the sweet spot of our economy. We need to stop fearing the Big Bad China and start capitalizing on its growth. We'll create jobs here at home and help replenish our savings if we do.

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