Tsunamis do happen

Tuesday, December 28, 2004 | , | 0 comments »


(A late addition to the 2004 collection)

The big winner amongst emerging markets in 2004 was Egypt. Investors would have seen their money return over 119% (as of 27 December 2004). Contrastingly, China, everyone's favourite - or so it often seems - fell nearly 15%.

Chinese economic growth has been astounding in recent times, and state marshalling of resources has played a significant role. Equally striking have been the social gains as measured by ratios such as life expectancy (72 years) and child mortality (25 per 1000 live births).

But economic and social gains do not always walk hand in hand. The most recent work arguing this is perhaps the New York Times video report, China's Great Divide. The bottom line is that China today is in many ways a contemporary re-enactment of the worst of the Industrial Revolution in 19th century Great Britain.

But with an important difference: there is no sign of a nascent free-press or political opposition developing in China. The non-growth economic consequence of having a supreme political monolith such as the Chinese Communist Party is the constant risk of misallocation of resources and associated risk of disaster.

It was misallocation - a large increase in state procurement of foodgrains during a poor harvest year - that severely aggravated the Great Famine (1958-1961). Grain was exported while rural communities had no food. Depending on which estimate is believed, 16.5 million to 28.5 million people starved to death. A free-press and active political opposition would surely have mitigated the human and economic catastrophe.

In terms of increased transparency, accountability and justice have matters evolved meaningfully since then? On a balanced reading of recent history the idea does not bear scrutiny. Resource misallocation continues by definition and there has been, to borrow a phrase, no great leap forward. The implications for foreign investment are significant. How would a business crisis, especially in the financial industry, pan-out in this Chinese system?

No, when something goes wrong in China, it goes wrong in a big way. Foreign investor hopes of consistently fair legal recourse and unfettered access to markets (WTO 2006 notwithstanding) ought to be seen in that light. It does not mean money cannot be made, but it does mean accepting the risk of a potentially very Bad Investment Tsunami.

(NB: life expectancy and infant mortality data for this article taken from the CIA World Factbook)

Post-script: readers may be interested in this follow-up piece which covers recent allegations of fraud on the part of a Chinese state-owned company against foreign investors.

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