The China Scare

09/29/2011 06:02 pm ET | Updated Nov 27, 2011

China's economic growth has left the West in awe. Some, like The Economist, believe that the East's rise and the West's decline are inevitable. Others, like Coca-Cola chief Muhtar Kent, argue that the developing world has been "learning very fast" while the developed one has forgotten "what really worked 20 years ago."

The Industrial Revolution gave the West the chance for "economic divergence," and subsequent military and political supremacy, as it amassed wealth that was not proportional to the size of its population, according to The Economist. But that was an "anomaly." Over the past decade, the emerging world (China, India and Brazil) has been closing the gap. Now is the time for "economic convergence," which will see the weight of the world economy shift from the West to the East. From now on, like before the Industrial Revolution, the size of the population will decide the wealth of the nation.

If such hypothesis stands, together with the Malthusian theory of finite earth resources, the world will go to war as the East tries to adjust the status quo in its favor, unless China gets caught in the so-called "middle-income" trap. This happens because the mercantile Chinese model is based on export. With sinking American and European demand, China will need replacement markets and will have to let is currency appreciate and urge its citizens to spend in order to keep its factories working.

But when the Chinese become rich, their pool of cheap labor -- which has given the nation much of its current growth -- will shrink and jobs will start fleeing to countries with cheaper labor. Cambodia and Vietnam are already "steeling" minion Chinese jobs.

Consumption might also turn China into another America as non-tradable jobs (services) replace tradable ones (industrial). National debt will rise and growth will slow down.

For China to overtake the West in ways other than being the world's biggest sweatshop or its largest mall, there must be alternative routes, and these seem out of reach given Beijing's current political system.

Like China, the West owes much of its world supremacy to prosperity. Yet unlike China, the rise of the West was not only economic. Democracy, freedom, equality and the rule of law have all contributed to Western advances. If the weight of the world economy shifts East, in the absence of such governance concepts, then our assumptions about the influence of the European Renaissance on Western ascendency are wrong, and economic power becomes a mere function of cheap labor wherever it is tapped.

China has not dominated the world yet, and it might not be able to do so through the creation of a business friendly environment alone. Kent's argument that countries like China are more inviting for businesses should be examined, especially given that China ranks 78 on the index of corruption, compared to say the United States, which ranks 22. It is hard to believe that corporations prefer more corrupt governments, even if those offer better tax brackets.

Lower taxes certainly attract some corporations. Washington should lower taxes for say Caterpillar to keep its factories open in America. But companies like telecom giant ATT have nowhere else to go if it wants to tap the huge American market. For Coca-Cola too, production offshore then importing into America is less profitable than keeping its American operation going, even at taxes higher than elsewhere.

In fact, despite its impressive economic growth, China is not easily accessible to all companies. According to Clyde Prestowitz, General Electric (GE) said it will transfer "its Synthetic Vision system (enables aircraft landings in extremely low visibility situations) and other leading edge technologies (often developed in part with U.S. government funding) to its joint venture with China's state-owned AVIC for production and sale to the state-owned aircraft maker now developing the new Chinese commercial airliner that will compete with Boeing in international markets in the future."

GE is clearly going after China's big market, no matter the tax bracket, and apparently regardless of long-term losses from transferring its exclusive technology. China is not growing because of its tax cuts, but because its government is luring multinational companies to develop its market, meanwhile forcing technology transfer that helps its companies to replicate products and then knock out the multinationals. This can go only as long as China has cheap labor. If China wants to become an economic powerhouse, however, it needs Research and Development (R&D), which in turn depends on free societies than can host peer-reviewed research.

No matter how much money China throws on R&D, its creativity will remain low with Communist Party shenanigans controlling universities. If universities become free, they might give the Chinese regime a hard time. If the press follows, it might challenge China's current economic policies and demand more transparency. Any alterations in China's economic system might change some fundamentals on which the Chinese miracle stands today in unpredictable ways. China's rise is all but guaranteed.

The West might still have a couple of assets up its sleeve. While it needs to replace its bubble-creating economic policies with ones that revive industrial production, its ongoing recession since 2008 does not tell of an inevitable decline and displacement from world leadership.