beyondbrics

Both bulls and bears like to compare Japan in the 1960s and China in 2010. Bulls say the comparison offers China a well-trodden path to a modern, high-tech economic future. Bears point to Japan’s asset bubbles in the 1980s, the subsequent crash, and the lost decade that followed.

Today a note by MF Global’s Nicholas Smith – provocatively entitled ‘The Sweatshop that Roared’ – came out on the side of the bears, warning that 1960s Japan was in much better shape than today’s China, principally because of one thing: education.

While policymakers in the western world fret about the many millions of graduates being churned out of China’s universities every year, Smith points not to the number, but to the quality of those graduates. Take engineers:

The educational system produces far too few properly trained engineers. McKinsey did a study of China’s looming talent shortage in a 2005 report, interviewing 83 HR professionals involved in hiring in low-wage countries: it concluded that only 10% of China’s graduate job candidates are suitable for employment by multinationals. Small wonder foreign companies in China complain of a talent shortage.

For those graduates that do find a job, there’s another problem.

Pay for recent graduates is below that for unskilled migrant workers and over a million remained unemployed – a sign the education system is tragically failing the parents that saved for it, and the economy generally.

Japan, says Smith, laid the foundations of its high-tech industry with education reforms dating back to the late 19th centry – which helped boost school attendance and literacy rates. China, by comparison, is still suffering from the legacy of the Cultural Revolution:

The effects are felt not only in the thinness of the cream in industry senior management, but also in the quality of leadership and mentoring in universities. A recent study by the Chinese government revealed that a third of the 6,000 scientists at 6 of the country’s top institutions admitted to plagiarism or the outright fabrication of research data.

As Jiang Xueqin wrote on China Power:

as long as the Communist Party controls the universities, they’ll continue to be political bureaucracies where professors care more about serving the agenda of some bureaucrat and fraud and cheating will become even more pervasive ‘non-problems’.

So what is the upshot of all this?

Essentially, Smith says that China will not follow Japan, and that it cannot forever be an export-driven economy. Wages will have to rise, growth will have to slow. The summary of his note presents a gloomy picture:

[China's] growth has come at the expense of wages, and discontent is bubbling to the surface in unseemly riots that make Japanese companies nervous about investing. By chaining its currency to the dollar it has manacled its monetary policy to US monetary policy, which is already resulting in disturbing asset bubbles reminiscent of those that humbled Japan.

Economic growth is likely to slow over the next 2-3 years, dashing the expectations of its citizens, with serious risks to stability at home and relations with its neighbours. China investments are no longer fire-and-forget.