Business Case Studies, Executive Interviews, Kai-Alexander Schlevogt on The China Factor

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Executive Interviews: Interview with Kai-Alexander Schlevogt on The China Factor
January 2008 - By Dr. Nagendra V Chowdary

Dr.Kai Alexander Schlevogt
Professor of international strategy
leadership at the National University of Singapore Business School
He serves as a Program Director of the Nestle Global Leadership Program
delivered in association with London Business School.

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    Even if the net impact of this redistribution from US exporters in China to domestic producers in the US on economic welfare is unclear, the following negative consequence will definitely prove highly detrimental to the whole US economy: Freed from the pressure to keep its exchange rate low, the Chinese government might stop buying significant amounts of US government debt. Interest rates in the US would increase, which would depress investment and growth.

    Incidentally, US politicians do not enjoy much credibility if they claim that they believe in free market forces, since they adopt protectionist

    measures whenever they think this is in the national interest. One example is the protection of certain agricultural produce.Interestingly, those who call for currency appreciation instead of simply demanding a flexible exchange rate regime, where rates can go up and down, unwittingly prove their dislike for market forces. In fact, contrary to what most pundits predict, the Chinese Yuan might actually depreciate if it is allowed to move freely, in which case exports from the US would become more expensive. This might be the case if China allows the Chinese public to freely invest their funds abroad, increasing the demand for foreign currency to buy foreign assets. In this case, US politicians, like Wolfgang Goethe's sorcerer's apprentice, might not be able to stop the spirits that they called!

  • "China exports inflation." Your comments please.
    On the one hand, China actually helped citizens in developed countries to enjoy the fortuitous combination of low consumer price inflation coupled with solid growth, and in the US, low unemployment. According to proponents of the Phillips Curve, which shows that employment is positively correlated with inflation, this is impossible. But cheap imports from China and domestic wage restraint in the face of the Chinese "reserve army" of laborers kept consumer prices low. Multinational companies that invested in China sourced a large amount of goods and services from their home base and thus contributed to GDP growth there. Besides, in the US, low interest rates, which were also "imported" from China, were conducive to investment in capital goods and housing, fueling GDP growth, too.

    Due to continuing government intervention, increased aggregate demand did not lead to price increases in the developed world, because China kept its exchange rate low. It prevented a decrease in aggregate demand in developed countries, since given the weak Chinese Yuan, net exports from China remained strong. Unwittingly, China paid dearly for literally "exporting" low inflation. It bought large amounts of low yielding US government bonds to subdue its exchange rate. By doing so, it incurred high opportunity costs in terms of foregone higher yields from alternative investments. Going ahead, it plans to diversify its asset holdings to some extent to improve yields.

    On the other hand, the prices of commodities as diverse as oil, steel and milk rose dramatically. Yet in industries such as packaged food, the increased input costs were not fully passed to consumers, since they could be partly compensated by lowered costs in other areas. The price hikes were partly due to increased demand from China, but it is not fair to assign the full responsibility for them to the Middle Kingdom. To start with, demand from other countries also rose. Besides, speculation explains part of the price hikes. Commodities were bought and, after prices increased, sold without the physical goods being moved. Further, government intervention in some developing countries led to unintended consequences. For example, in the wake of policies that promoted renewable energy, more agricultural fields were used to grow crop that could be used as bio fuels. Production of other agricultural produce was cut back. It is not correct to blame China for the price hikes that resulted from this reallocation of resources.

    Future changes in commodity prices will depend on the quantity of demand and supply, as well as their price elasticity. For example, when demand for milk increases significantly, farmers may not be able to increase supply immediately to satisfy it. In this case, the supply curve would be vertical. Prices would need to go up for the market to clear. But within a couple of years, farmers can increase their life stock. Holding other things constant, the increased supply of milk would cool prices down. When the relative price of renewable energy decreases, consumers may substitute it for fossil fuel. The decline of demand for oil, ceteris paribus, would dampen its price.

    Future changes in the Consumer Price Index (CPI) depend on movements in aggregate demand reflecting changes in consumption, investment, government expenditure and net exports, as well as changes in aggregate supply. Competitive dynamics a function of industry structure and company behavior will determine to what extent potential increases in commodity prices are passed through the value chain and thus indirectly affect consumers. The direct impact of the commodities on the CPI depends on their weight in the consumer basket. Even the combination of inflation and recession so called stagflation is a possibility. In this case, savings are inflated away and income shrinks at the same time.

  • Do you think that the excitement about China is a case of irrational exuberance or overdue optimism?
    Leaders around the world must develop a realistic view of the opportunities and risks in China instead of being blinded by excessive enthusiasm. I know many CEOs who are just following the herd. They get excited about the buzz about China and do not want to go down in their company's history as the leader who missed the gold rush. Their greatest concern is not to fail, but to fail alone. Clearly, this is not a good reason to invest in China, since the herd can be wrong.

    It is equally dangerous to frame China solely as a menace instead of focusing primarily on the opportunities. Numerous studies in the field of psychology have shown that so called threat bias often prompts people to overcommit resources. A clear sign of threat bias is the fear of missing the "last" train, such as obtaining a license, despite the fact that in most cases new attractive chances will emerge in the future.

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