Back in the middle of 2008, many publications, most prominently The Economist magazine, suggested that a downturn in developed countries might not have any significant effect on developing economies, since the latter have already "decoupled" and are no longer heavily dependent on demand from consumers in rich countries.

Within a few months, the "decoupling" theory proved to be false: The downturn in the developed world had a significant impact on China's economic well-being, causing a dramatic rise in unemployment and a sharp slowdown in economic growth. The Chinese government, just like the American one, responded with massive stimulus spending and expansion of cheap credit.

 

As I noted back then, the assumptions made by The Economist and other leading publications concerning China's growth are false. A new study published by Professor Hung Ho-fung at the New Left Review (of all places!) provides some interesting information that helps put things in perspective. The article compares China's development path to that of other Asian economies, including Japan, Korea, Taiwan, Singapore, and Hong Kong. It provides a concise summary of political and economic events in East-Asia since World War II as well as some colorful predictions and recommendations, but for the purpose of this post, I will only mention some of Prof. Hung's key observations:

1. Private consumption as a share of China's GDP has been going down consistently since the early 1960s, including a dramatic drop following China's "Reform and Opening Up" policy at the end of the 1970s. 

2. The average wage of a Chinese manufacturing worker in comparison to his American counterpart remained constant over the past 30 years, hovering around 2%. This means that despite the massive increase in Chinese exports to the US, a Chinese factory worker still earns a 50th of his American counterpart, just like in 1980. In comparison, the average wage of Japanese manufacturing workers in comparison to their American counterparts went from 7% in 1950 to nearly 60% in 1980. Korean manufacturing workers enjoyed a similar relative increase in their buying power between 1975 and 2000, as did their counterparts in Taiwan. 

3. Over the last 30 years, China saw a 40 fold increase in private consumption. In the same time, however, there was also a 180 fold increase in fixed-asset investment.

So, in the real world, China's economy is becoming increasingly dependent on investment in fixed-assets (by government, or via government-induced loans), and depends less, not more, on local consumption. China's development trend and growth in real manufacturing income is very different from that of other "Asian Tigers" and seems to offer a very limited benefit to those working at the lowest paying jobs - which means they are not going to become the world's new consumers any time soon. 

It looks like the only decoupling we have been experiencing over the past 12 months is a decoupling from reality - a growing gap between what we read in the papers and what really happens in the global economy. There is a lot of growth in China, and while some people are making more money, there are even more people who aren't, and a few people who make more than most of everyone else combined. And while there is an increase in retail spending, local consumption is not likely to become China's main growth engine any time soon. 

We live in a time of immense confusion. Words that used to mean one thing suddenly mean another. The values which made us prosperous and free are being questioned and trampled on. We are in a mess, and our instinctive reactions seem to make things worse. 

In 1989, following the collapse of the Soviet Union, Francis Fukuyama declared "The End of History" and noted that 'The triumph of the West, of the Western idea, is evident first of all in the total exhaustion of viable systematic alternatives to Western liberalism'. Twenty years later, the ideological appeal of classic liberal values  - free markets, property rights, civil liberty, and individual responsibility - is in decline, following an economic meltdown in developed countries and the perceived success of the authoritarian-socialist model, most notably in the People's Republic of China. Capitalism as we know it is dying. Some say it already died a long time ago. 

Schumpeter opens his most famous book by asking 'Can Capitalism Survive?', and immediately responds 'No, I don't think it can'. Schumpeter was not a Marxist and did not wish for capitalism to perish, but he thought that capitalism's evolution into a new form of socialism was inevitable. At odds with the Marxist view that capitalism would be destroyed by the angry "proletariat", Schumpeter believed that 'capitalism would be destroyed by its successes'. 

But why? And how? Since most of you are busy people, I prepared a brief summary of Schumpeter's main points, based on Capitalism, Socialism, and Democracy, as well as other publications, most notably The March into Socialism, a speech he delivered shortly before his death. While his work covers a broad array of issues - entrepreneurship, democracy, consumerism -  my summary will focus on his ideas concerning the decline of capitalism. 

Before we proceed, it is important to put things in historical context. Schumpeter was born in a world divided between imperial powers. He witnessed the triumph of America and England's relatively pure form of capitalism during the final decades of the 19th century and beginning of the 20th century. Back then, capitalism was synonymous with small government and individual responsibility. Schumpeter saw the erosion of this notion through the establishment of many institutions that seem to us, today, as god-given components of any capitalist system: When Schumpeter was 20, the US had no Central Bank, no progressive Income Tax, no military industry of any significance, no social security, and no government healthcare. 

Schumpeter wrote his book at a time when only 14% of government expenditure was funded by individual income tax, as opposed to about 40% today; The expenditure on defense was about 1.7% of US GDP (in 1940), and is over 3% today. In 1960, ten years after he died,  spending on Health and Human Services still took less than 3.5% of all government expenditure, compared to about 25% in the 2000s.  The total Federal Government outlays in 1940 amounted to 9.8% of US GDP compared to about 20% during the 2000s - and that's before taking into account the recent government bailouts and stimulus packages, which take these numbers completely off the charts (additional historical data can be found in this PDF report published by the White House). Most importantly, Schumpeter lived at a time when the US Dollar was (mostly) tied to gold, and the government was severely limited in its ability to create new money and generate inflation. 

Government control of economic affairs has grown by leaps and bounds during the last 60 years, and many of the things that we now take for granted were considered purely socialist back then. Ironically, the fact that so much has changed, and that we still call our current system "capitalism", makes it somewhat difficult to understand how astute Schumpeter was in his prediction of capitalism's demise. We might be proud to claim that capitalism is still alive and well, but - based on how much it has changed - many would argue that what we still call capitalism is simply a sophisticated form of socialism. 

Stay tuned for Part II.