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Dr. Philip Neches

Dr. Philip Neches

Posted: March 8, 2010 03:51 PM

The Sun Also Sets

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In 1989, the US semiconductor memory industry was on the ropes. Intel, the company that invented the DRAM, the most popular kind of memory chip, abandoned the business it pioneered to focus on microprocessors. Although that would turn out to be one of the most brilliant calls in the history of business, nobody knew at the time. US producers struggled with profitability and product quality.

In a larger sense, Japan was on a roll, dominating industry after industry: steel, shipbuilding, automobiles, consumer electronics. Japan was threatening to become the dominant power in fields as high tech as semiconductors and as primal to capitalism as banking and real estate.

The fear in executive suites and the halls of Congress was palpable. When I was a senior executive at NCR, IBM tried to get us, and the other major US computer companies, to join forces to make semiconductor memory in the US, using IBM's advanced designs. We declined, but with considerable trepidation.

One of the most important books I ever read came out that year, and it totally changed my view of the "threat" from Japan. Ironically named for the Ernest Hemingway novel, The Sun Also Sets by Bill Emmott methodically explained the rise, and the coming fall, of Japan in clear, simple terms of demographics, the science of human population.

The US had massive "baby boom" after World War II, which included your humble blogger. Japan did not. Japan, Emmott wrote, was shortly to face a rise in retirements not matched by young people entering the work force. Closed to immigration, Japan would have fewer workers supporting more retirees. While people working towards retirement are savers, retirees are "dis-savers" who must spend down their savings to support themselves. Since Japan's public social security system was (and is) quite weak relative to public retirement systems in the US and Europe, individual Japanese were compelled to be heavier savers during their working careers, and would become freer spenders in retirement.

This made far more sense to me than confused cultural stereotypes that floated around boardrooms, like a mistaken belief that saving is more of a virtue in Confucianism than Christianity. People on either side of the Pacific reacted in a rather rational way to the demographic and economic environment they lived in. This drove a higher savings rate in Japan and a lower rate in the US, which translated into cost of capital, which translated into corporate behavior. The Japanese could sell DRAMs for less that Americans could because their cost of capital was 6% and ours was 14%. They could invest more aggressively in the latest equipment. They could carry more inventory. And they could price lower in a highly capital intensive business, while still making a profit.

But it was all about to change, according to Emmott's book. Japanese salarymen would retire in every greater numbers. The national savings rate would fall. The cost of capital would rise. The values of the yen, Tokyo real estate, and Nikkei listed stocks would become unsupportable, and the bubble would burst. Japan would still be a modern, prosperous country. But it would not be in a position to dominate the world through commerce.

And it happened just that way. Japan was sitting on a demographic atom bomb, and it went off right on schedule in the 1990s.

Today, we worry about China dominating the world economy and thus world affairs. It is hard to go through a shopping mall without finding "Made in China" labels on every shelf. Every day, we read headlines in the business pages and front pages about China investing in everything from nuclear power plants to cell phone infrastructure to 3D movie theaters. The leaders of China don't have to abide lectures on civil rights from debtor governments, like us.

China, however, sits on a population H-bomb. Since the 1970s, China enforced a "one child" policy with ruthlessness and efficacy that democracies can not emulate and should not envy. The supply of young people dropped. At the same time, China had a public health revolution comparable to what took place in the US between 1890 and 1940. With control of infectious diseases, the death rate dropped to about a third of the historic rate. Life expectancy zoomed from 30+ years to 70+ years. In other words, China is creating a supply of old people at a rate that dwarfs its production of tschochkies for Wal*Mart.

Put bluntly, China is in a race to get rich before it gets old. They will lose.

Some of the consequences are predictable. The Yuan will strengthen relative to the dollar, making outsourcing to China less attractive. Asset values will fall, starting with foreign investments held by China, like US Treasuries. Market forces will drive down the value of similar assets within China. Like Japan, China can try to forestall the impact by a combination of "creative" accounting and government intervention. It will only prolong the agony.

The political consequences are harder to anticipate. The LDP, the party in power in Japan since World War II, fell just last year after over 15 years of economic underperformance. The Chinese Communist Party will try to stay in power with all of the effort and wiles of any dynasty. Chinese dynasties fall when popular unrest overwhelms the forces of control. Events within China, and what the Chinese government might do abroad to distract from internal problems, could be the headlines for decades to come.

It will happen. Demographics are destiny, and the sun also sets.