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Thursday 23 April 2009

Why The Growth of India and China Means Our Kids Should Do Media Studies

Software Isn’t Hi-Tech Any More

Last year I visited China in my role as an IT guy and, as usual, got into a discussion about the additional software services we might sell in addition to our products. The manager I was trying to talk to just smiled and beckoned me to follow him. We wandered down a few corridors and passed through a door that opened up into an aircraft hanger of a room filled, end to end, with serried cubicles staffed by young Chinese writing software.

The point, of course, was that there were no software services I could offer that the Chinese couldn’t support themselves, cheaper. The West has yet to fully appreciate the impact of the transition of China and India to fully industrialised nations. Our children need to start looking for new sorts of jobs, now, or spend the rest of their lives stacking shelves in supermarkets.

Transitioning from Agricultural Societies

Estimates suggest that around 1.2 billion of China and India’s 2.3 billion combined population still works outside the industrial sector. First world economies use approximately 3% of their available labour to till the land so that would imply over a billion people spilling into the globalised industrial economy at some point in the next few decades.

These countries are throwing out engineers, scientists and IT people at a rate far beyond what we in the West can achieve. Meanwhile our media obsessed younger generation shows a marked disinclination to engage in these areas which, as it turns out, may be a pretty intelligent decision. In competition with people at least as well educated as themselves but paid ten times less the opportunities for such skills are likely to be significantly reduced over the next twenty years.

So what’s left for the rest of the world if China, India and other South East Asian economies are going to become the global IT engine room? Where does this leave us as investors?

Global Resources

A second consideration is about the resources needed to fuel this growth. The development of the global media exposes the have-nots of the world to that which the haves, have. A Chinese friend of mine recalls walking out of LA airport in the late eighties and standing, stunned, at the sight of more cars than he’d ever seen in his entire life before: a lifetime of indoctrination was broken in a moment.

Yet the realities of global economic growth dictate that the world can’t support its poor becoming wealthier. For all Indians and Chinese to attain first world wealth we would have to strip the planet of its minerals and energy sources in an unsustainable frenzy of global proportions. In the words of Worldwatch:
...if by 2030 China and India alone were to achieve a per-capita footprint equivalent to that of Japan today, together they would require a full planet Earth to meet their needs.

This isn’t going to happen. Yet the invisible hand must work and the redistribution of global wealth will happen. If India and its cohort can’t attain first world wealth then the latter must drop to meet the competition coming up. In short – we in the West, or at least our children, are going to be poorer on average.

Investing for the Future

Leaving aside the issues of planetary destruction and the inevitable decline of western society for a moment, we need to consider what difference this makes for us as rational investors. The obvious answer, investing directly in these economies, isn’t as easy as we’d like.

As we’ve seen before although investors are, as a whole, pretty good at figuring out which areas or stocks will outperform they are, as a whole, uniformly bad in avoiding underpaying for them. Value stocks appear to outperform growth stocks because investors overpay for growth rather than underpaying for value (see Clairvoyant Value). Investing in high growth, but expensive, Eastern stocks is likely to be a losing play, long term.

The Commodity Play?

The growing economies – especially China - are relatively short of commodities to fuel their growth. The search for sources of these will no doubt continue but the potential or actual impact of this saw oil and other commodities spike alarmingly in 2008.

Commodities generally obey the marginal laws of pricing deduced by David Ricardo. Simplistically, if supply of a commodity exceeds demand then the price of the commodity will tend to the cost of production: if it goes lower than this companies will eventually stop production entirely. However, if demand exceeds supply even marginally suddenly the producers are in a position to charge excessive prices.

The OPEC Effect

We saw this happen in the 1970's when the creation of OPEC suddenly restricted oil supplies causing the price to spike because demand exceeded supply. The consequence, over many years, was that industrialised nations moved to reduce their consumption of the black stuff until OPEC was no longer able to force its members to cut supplies any further and the price collapsed back to its cost of marginal production.

Something similar happened last year when emerging economy growth drove demand up without a significant increase in supply – although whether this was a genuine increase in demand or purely a speculative reaction by hedge funds (as suggested in Hedge Funds Ate My Shorts) and other investors is still not clear. Whatever, the effect was a sudden and dramatic spike in oil and other commodity prices.

If China and India do continue to industrialise at the current rate then commodities are a way of investing in that growth. However, it’s a risky play: price rises will drive the world to look for ways of reducing consumption of oil and minerals. We’ve been given a warning, which is unlikely to be forgotten quickly. Still, these types of effects take years to play out so there’s a trade off between the speed with which industrialisation takes place and the rapidity of the reaction to price rises.

Buying the West

The psychological trap that investors typically fall into is chasing the next growth story. Checking where the investment industry is feverishly offering new funds is as good a sign as any. Guess what they were marketing a couple of years ago? Looking at closed end funds in emerging markets trading at big NAV discounts may not be a bad idea, if you trust the fund managers not to merge the funds out of existence.

However, the best way of investing in these countries may be simply to invest in undervalued Western companies that are using their cheap labour and finding ways of selling into the East. Given a choice between expensive Eastern stocks and cheap Western ones the latter will provide investors with better returns even if the former grow much more rapidly than the latter.

Unfortunately, as far as I can tell, there are no passive funds that allow such an investment. For long-term active investors with a value mindset focusing on such companies should offer very decent returns: almost certainly far better than buying companies on high multiples focusing on the trendy areas of climate change and alternative energy.

Services and Skills

On the local level we’re back to services. Some of this is relatively high-end stuff as well – power generators, infrastructure management (water, airports, etc), doctors and lawyers for instance. Lots of it, though, is simply box shifting. As far as I know you can’t easily get someone in India or China to stack UK shelves.

For our kids there’s no easy escape from the equalisation of the global economy. They need to develop language and design skills, focus on doing things that can’t be transferred abroad and, above all, rely on their parents for handouts while they get established. For us it’s an investing opportunity but for them it’s going to be a crisis.

Related Posts: Copper at Morewellham Quay, Reality 2.0 - Interactive Porn and the Breeching of Moats

1 comment:

  1. Whenever I read essays like this, I am glad of two things:

    1. I don't have children
    2. I spend almost no effort trying to prolong my lifespan.