Tuesday, 17 May 2011

Why Progress Needs Ideas

Guest post by Kris Sayce

Why Progress Needs Ideas

Last week we wrote there was something troubling us.  Let’s see if we can explain…

You can barely open a newspaper or read a financial report without someone claiming China is set to take over from the US as the world’s economic powerhouse.

We’re not so sure.

The way we see it, much of what China’s achieved in the past 30 years is down to cost cutting.  In other words, China has made things cheaper and faster than any other economy.

It has built massive factories and assembly lines to churn out billions of units of products.  According to The World Bank, China:

  • Manufactures 40% of all microwave ovens sold in Europe
  • Manufactures 70% or the world’s metal cigarette lighters
  • Makes more than 50% of the world’s cameras
  • And 25% of the world’s televisions

Yet, just like a business, there’s only so much you can achieve through cost cutting.

A business that only cuts costs tells you it’s short on ideas for increasing revenue.

And that’s the kicker.  Where are China’s ideas?  Where’s the innovation?  Where’s something new and revolutionary?

Spot the difference

Let me put it this way. Apart from the size, what’s so different about the factories churning out 70% of the world’s lighters compared to the factories in Europe or North America that used to make lighters?

Hey look, we may be wrong on this. But frankly, we’re struggling to think of a single innovation China’s businesses have unleashed on the world economy over the past 30 years.

Sure, we hear how China has opened up as a market economy (it isn’t really, it’s still centrally controlled by the Communist Party) and how this has caused massive economic growth.

And maybe it has.  You only have to look at a chart of China’s GDP since the early 1980s to see that:

Source: Google, World Bank

But doing things cheaper doesn’t necessarily mean progress or innovation.

As an example, in the April issue of Australian Small-Cap Investigator we wrote about changes to the manufacturing of steel that resulted in extraordinary change to the world.

The North American and European railroad industry went ballistic.  Rails were laid from city to city, mine to port and factory to wholesaler.

Not only that, but steel allowed engineers to build bigger, better, stronger and taller buildings… enabling the urbanisation and concentration of the population.

But here’s the thing.  Steel didn’t take hold because it was cheaper (in fact, for many years it was more expensive), steel took hold because it was more durable and stronger than iron.

More than price

Eventually, due to the demand, the cost of steel dropped until it was roughly the same price as iron.  If engineers and railroad moguls were prepared to use steel when it was more expensive than iron, it was a no-brainer for them to keep using it as the cost fell.

The development of the steel manufacturing process filtered through to encourage further innovation and improvements.

But it wasn’t cost that was the immediate driver.  Costs only fell after steel had become a proven and in-demand material.

And if you think about it, when innovation is concerned, it doesn’t always lead to lower costs.  Sometimes, the price is higher for the replacement good.

It’s just the replacement good offers something the old good doesn’t.  To use an extreme example, think of it like this…

An iPod Touch will set you back over $250.  You can store music on it, take photos, store photos, play games and even make wireless video calls.

Yet, you can buy a cheap cassette player for about 20 bucks.  A disposable camera for the same.  A photo album for less than 10 bucks.  A puzzle book for a fiver. And a mobile phone for 50 bucks.

If it was just about price, then no-one would buy iPods.  But price isn’t always the main issue.

People buy iPods because they have certain advantages over those other items.

Or think of the cost of a computer against the cost of a pen, notepad and filing cabinet.  A personal computer allows you to do so much more, even though it’s more expensive.

In other words, “cheap” isn’t the same as innovation.

Now, before we’re accused of China bashing, we’ll admit if you search the Interweb for “Chinese inventions” you’ll get pages and pages of innovations and inventions.  Trouble is, not one of them is within the last 500 years.

So, where are we going with this?

Smart or clever

Simply this: in terms of economic innovation and progress, the Chinese economy has contributed nothing in the past 30 years.  All it has done is provide cheaper labour and taken advantage of Western economic inflationary and deficit spending.

That’s smart, but not clever… if you get what I mean.

When the United States became the world’s biggest economy at the expense of Great Britain, was it because the US was cheaper?  In some cases that was part of it. But it was also because businessmen had innovative new ideas.

There was progression from old technology to new.  There were new ideas.  Some ideas were adapted from Europe while others were brand new ideas.

If you think about it, despite the growth of China, most of the innovative new ideas have still come from the US.  The difference is that increased red-tape and regulation has forced much of the US’s manufacturing to be sent offshore, meaning the US economy doesn’t get the full benefit of all of its ideas.

The upshot for China is that when higher labour costs start pushing up the cost of production in China, China will lose its only competitive advantage – cheap labour.  Sure, it will have time to innovate… and maybe it will succeed.

But after 30 years and billions of dollars spent by consumers, what legacy has China left so far?  As far as we can see, not much.  The Chinese economy is built just as much on consumerism as the US economy.

One is the consumer, the other the supplier.

But the fact you’re talking about two different nations doesn’t mean one will survive if the other collapses.  What’s happening between China and the US is little different to the relationship between Australia’s resources states and the non-resources states.

One is subsidising the other: China lends the US money so the US can buy goods from China.  Australian resources companies lend to Australia’s consumers via the banks so they can consume.

To our mind, relying on the Chinese consumer to get the world economy out of a hole is wishful thinking.  It’s just replacing one bunch of consumers with another.

Progress needs ideas

If it was as simple as that there would be no need to innovate.  But without innovation the world is destined for a modern-day dark ages – where there’s no incentive for anyone to achieve anything and there’s no prospects for improved standards of living.

Because once costs are reduced to the minimum possible, there’s no incentive for new businesses to compete… not unless they can innovate with a new idea.

Progress is all about ideas.

But until we see innovation rather than replicating old ideas – dams, tall buildings and nuclear power stations are hardly innovative – we’ll continue to sit on the sidelines and let others get excited about the Chinese Dragon.


Kris Sayce
Money Morning Australia

1 comment:

  1. Elijah Lineberry18 May 2011, 18:33:00

    You heard it here first, folks! -was writing solopassion.com posts about this 4 years ago, *wink* but delighted the 'little people' have finally caught up with their master... ha ha!


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