East Asia Under the Midday Sun

By: Steven Lachance | Thu, Jan 5, 2006
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Forecasters tend to get ahead of themselves when peering into the future. Occasionally, though, the reverse is true; the future sneaks into the present while a lens crafted for self-flattery distorts our perception. Today's consensus view of the global economy is a case in point. Our esoteric GDP figures show the Western OECD member states accounting for two thirds of the world's economy, and we feel reassured that even if China and its neighbors may own the future, at least the present is ours. Wrong. Nearly half of global industrial production is already concentrated in just three countries, Japan, Korea, and China, and the rest of the world is quickly being reduced to productive redundancy as they tighten their hold on value-added manufacturing and its technological underpinnings. The mainstream economists of the West believe their post-industrial economies can forego the supply side of the output equation while their consumption grows indefinitely on the demand side. To flatter us further, they insist East Asia must pay the difference or suffer the consequences: have their stacks of irredeemable IOUs become worthless and be left with nothing but the lion's share of the world's capital stock.

Learning what really counts in the wealth of nations

In August 1863, a British naval squadron steamed into Kagoshima Bay and bombarded the castle of the Daimyo of Satsuma, who instead of turning red with anger, turned green with envy. He was so impressed by what he had seen he immediately asked the British to form an alliance, and let his engineers have a closer look at those canons. Five years later, the sailors of Satsuma, together with the soldiers of Choshu, marched into Edo as the last Shogun fled after nearly three centuries of Tokugawa rule. The feudal era was over and the Japanese began the daunting process of building a modern industrial economy; learning, saving, investing, and otherwise sacrificing the here-and-now for future personal gain as a hundred million of Adam Smith's invisible hands pressed forward. Within a few decades their efforts began to bear fruit and, in 1919, Japan sat alongside the great powers of the West at the Peace Conference of Versailles.

At the same time, many frustrated Chinese were asking the rhetorical question: why are we so large and weak, and they so small and strong? For many years they failed to find the answer that had been presented so graphically to the Daimyo of Satsuma: industrial inferiority. For the country's long torment, the nationalists blamed foreigners, the communists everyone but themselves. Until Deng Xiaoping. Deng had drawn the same lesson as his Japanese predecessor through a remarkable replay of personal history. During his stay in France as an exchange student in the early 1920s he worked as a fitter at a Renault tractor factory in the Paris suburb of Billancourt. Nearly fifty years later, now in his mid-60s, he was banished from Beijing by the Red Guard and sent to Jiangxi Province to relearn the values of the proletariat by working yet again as a tractor fitter. In the interim China had stood still. The tractors were the same as those he had worked on in Billancourt; the country remained so large yet so weak. Deng resolved to use whatever cat could catch mice, no matter its color. China adopted capitalist reforms in 1978 under his leadership and the East Asian growth dynamic gathered pace.

The West loses its bearings

Before the economics profession was harnessed for political ends in the first half of the twentieth century, the process of capital accumulation was properly understood as the source of the West's prosperity and technological superiority. This process had it roots in the Renaissance in general, and the invention of the balance sheet by Italian mathematician Luca Pacioli in particular. Goethe called the balance sheet the finest product of the human mind. For the first time, shareholders' equity could be measured precisely, the precondition for the establishment and management of a joint stock company. With this compass to navigate by, managers could keep the enterprise well balanced between risk and return, and confidently pursue even such previously impractical large-scale projects as shipping lines and railroads. The national economies of Western Europe were transformed from a patchwork of cottage industries into a modern capitalist system in which an increasing division of labor drove an exponential rise in productivity and efficiency.

The corruption of the balance sheet so commonplace today is as foolhardy as a wayward mariner tampering with his compass. Removal of expenses off balance sheet (stock options) is akin to erasing the markings of reefs and shoals on navigation charts, while inappropriately transferring liabilities into the assets column (pension accounting) is tantamount to burning the boat piecemeal once the fuel runs out. The rise of the West began with the innovation of the balance sheet and the slump back into mediocrity is the result of its corruption. The proper application of time-honored accounting principles would decimate much of the shareholders' equity shown on the balance sheets of US companies today. It would expose the last two decades as a period in which capital was consumed, rather than accumulated.

Capital accumulation in East Asia

The concentration of productive capital in East Asia relative to the rest of the world is now on par with that of Western Europe in the second half of the nineteenth century. Collectively, Japan, Korea, and China, including Taiwan and Hong Kong, produce essentially all of the world's ships, LCDs, and electronic components, two thirds of its consumer electronics, office equipment, appliances, and computers, and half of its steel, precision instruments, transport equipment, semiconductors, and machine tools. Japan alone is home to half the global population of industrial robots, all of which were built by its domestic industry. East Asia deploys over half of the world's engineering workforce and its capital investment in manufacturing is greater than that of the rest of the world combined.

Again, the consensus view in the West is as sanguine as it is misleading: this is simply the result of a natural flow of productive capacity to low cost bases; the universally acknowledged labor arbitrage. Value-added production, however, is not shifting to Latin America, Africa, the Middle East, or South Asia, where labor costs are even lower than in East Asia for the most part. It is overwhelmingly migrating to East Asia, including Japan, where labor is more expensive than in the US or the UK, and to Korea and Taiwan, where labor costs significantly more than in Eastern Europe. The labor arbitrage view is irreconcilable with Japan's trade surplus with China and China's flooding of other developing countries with manufactured goods. This is not globalization, but the accession of East Asia to the throne of global economic dominance. From this perspective, the potential bankruptcy of the region's central banks as a result of the devaluation of their vast dollar holdings is immaterial. Paper currencies and the financial systems based on them come and go relatively easily, the capital and technological base for value-added industrial production, in contrast, takes generations to put in place. It is this hard-earned legacy, not a house of fiat currency cards, that will keep East Asia under the midday sun for years to come.


Author: Steven Lachance

Steven Lachance
Tokyo, Japan

Copyright © 2005-2006 Steven Lachance

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