More evidence of risks investing in China

On the back of lowered Chinese Communist Party targets for economic expansion, the Economist is noticing a series of trends cropping up in China - higher wages, more difficulty adding workforce and above all the need to innovate in order to continue expansion - trends the Strategic Investor suggested as far back as 2007, would begin to manifest themselves in 2012.

How could we be so accurate - simple, we just looked at the simple math of economic expansion (which, despite claims of "miraculous" activity everywhere from West Germany to Korea, is actually quite straightforward).

GDP is simply the product of hours worked and outper per hour.  China faces challenges in both places.  For the past 30 years, China has been able to lift both by increasing workforce participation (by limiting births and time off, keeping women in work) and by employing that labor at higher output factory jobs (albeit labor-intensive ones).  But after decades of low birth rates, the Chinese workforce has finally peaked, which means that unless the Chinese can find a way to keep more older workers in the workforce (tough when many jobs are physically demanding), hours worked is likely to fall.  Of course, if the remaining workers were to work more hours, hours worked could be maintained, but hours worked is not terribly elastic, and if history is any guide, rising incomes will lead to FEWER hours worked, not more, as workers use higher incomes to consume more leisure.

What of higher productivity?  Increasing output per hour is a certainty in China, as the capital stock increases, there will be gains in worker productivity.  These gains will likely be slower, however, because China will have to have better managers to organise the labor around knowledge work, and because success in more cutting edge technologies involves innovation, not duplication.  Here, Communist regimes have a dismal record, which is more or leses echoed by the Economist.  China has few, if any, global brands that are truly home grown.  Lenovo, after all, became famous by purchasing the PC assets of IBM.

China still has many advantages, as do the US, Canada, the UK and Germany.  But as China "catches up" with them and attempts to invade space they now occupy, it will struggle with the limitations of its economic model.  I expect a hard landing in China before the decade is out - possibly as early as 2015.