Elmore Alexander on Management: August 2016

Any visit to China is striking. The size of everything is overwhelming. The contrast of old and new is striking. If you’re revisiting, the obvious growth is a shock. If, as was the case for me, the time span between visits is over 10 years, the change can be almost impossible to fathom.

In the interim between my visits, China created the Shanghai Pilot Free Trade Zone. This 11 square mile industrial/international trade park located outside of the city and adjacent to the airport opened in 2013 to experiment in financial and foreign investment changes designed to make the Chinese economy more open and accommodating. It is impressive. From the ornate entryway reminiscent of gateways into Chinese communities to massive warehouses for imports and exports to high rise headquarters for multinationals and Chinese administrative offices, this is obviously a new and different China. My group saw everything from a wine importer with a cellar to rival almost any in the world to a retail store that was a mini Wal-Mart. The names on the outside of buildings were a virtual "who’s who" of multinationals.

The most interesting part of the Zone to me, however, was a visit to the trade administration building. This is the comprehensive service center for the Zone—the place where you go to fill out all of the paper work that lets you conduct business. The building is the tallest in the Zone, and it was hopping with activity. Imagine a Department of Motor Vehicles office in any U.S. state and you’ll get the picture. But this is China—we’re talking about the DMV on steroids. We were only allowed to enter in groups of five, and what we saw were lines after lines of individuals. The individuals not standing in lines were sitting waiting to stand in lines. And, of course, our guide pointed out the line that you stood in to find out which of the other lines you needed to stand in. Our guide talked exclusively about rules, regulations and bureaucracy while assuring us that the strategy was to make doing business easy and convenient. I had my doubts.

My research upon returning home confirmed my observations—“all that glitters is not gold” in the Shanghai Free Trade Zone. Let me direct you to three articles that I found informative.

One year into the operation of the FTZ, MacKenzie Sigalos argued that the FTZ was a “dud” noting that trade reform was slow and that there was significant confusion about what can and cannot be accomplished in the zone. http://money.cnn.com/2014/10/06/news/economy/shanghai-free-trade-zone/)
A year later, an article in Worldwide Financier (http://www.financierworldwide.com/impact-of-chinas-free-trade-zones/#.V8LptPkrLX5) noted that the impact of the FTZ on both foreign and domestic trade had been negligible. Government reforms had been limited and impact on the Chinese economy in general had not been significant.
Reporting from Shanghai, Gabriel Wildau argued last September that the FTZ “lacked relevance” http://www.ft.com/cms/s/0/8cec0faa-6364-11e5-9846-de406ccb37f2.html. While he notes that clearing goods through customs has now fallen from weeks to days, progress in market liberalization has been slow.

None of this should be surprising. Even getting goods across the US-Canadian border can be complicated and unreasonably slow. And everything about the Free-Trade Zone is not negative--moving clearances from weeks to days is significant. It does emphasize, however, that there are no easy solutions to any problems. Infrastructure enhancements like the Shanghai Free-Trade Zone are important steps to more open trade. Cultural impediments cannot be ignored. Truly free trade will come at the end of long negotiations and even longer experience with trade relationships.

In a recent blog (“Chinese Manufacturing Productivity”), I wrote about the problems of Chinese productivity, noting that, while growth rates were high, the absolute level of productivity was between 15-30% of OECD averages. This week, we were disappointed, but not surprised, to learn that US output per hour worked fell 0.5% in the second quarter to end up down 0.4% over the last year.[1] Most writers point to the beginning of the Great Recession as the proximate cause of this decline. However, productivity actually began to fall before 2008.[2]

I recalled that, back in the early 2000’s, I invited one of the regional Federal Reserve Bank presidents to speak to MBA students at my university. He proposed that productivity increases spurred by the revolution in information technology had reset the classic relationship between unemployment and inflation. He predicted continuing growth in both productivity and GDP and declines in unemployment without any impact on inflation. But the promise of information technology and unlimited productivity growth faded. And then came 2008!

So where are we? Have we found the 21^st Century equivalent of “stagflation” (low growth coupled with high inflation of the late 70’s) in a new equilibrium of anemic growth despite low interest rates? Not necessarily.

The driver that led to what Alan Greenspan and Robert Shiller characterized as “irrational exuberance”[3] was the impact of information technology on the economy. Information technology drove productivity and productivity drove growth. However, despite the expectations of my Fed prognosticator, this cycle came to an end. When you add in the impact of the Great Recession, you get the slow growth recovery that we’re now experiencing. A recent article by Neil Irwin, [4] one of The Upshot writers at the New York Times, posits three theories for our current situation:

The Depressing Scenario—technology has done what it can and productivity will not improve;
The Neutral Scenario—the economy is so dramatically changed that our measures just can’t keep up;
The Happy Scenario—we’re in a stage of investment in new technologies that will take several years to kick in but will ultimately yield dramatic productivity increases.

Personally, I subscribe to the Happy Scenario. A recent Brookings Report[5] detailed some of the drivers of such a perspective:

New technologies in energy
Industrial robotics
3D printing and active manufacturing
Big Data
The “internet of things”
Investment in infrastructure

Each of these drivers has significant implications for the logistics industry. While research on driverless vehicles and Big Data may be consuming huge investments today with minimal returns, no one doubts their ultimate impact. Furthermore, the presidential candidates of both political parties have championed investment in rebuilding our network of highways and bridges. The impact of even a modest increase in such spending will have a dramatic impact on GDP and productivity and, particularly, on logistics productivity.

Is this a time to be complacent? No. Do we want to chauvinistically ignore Chinese productivity growth? No. As I argued in my last blog, it’s time to “double down” on innovation and technology not to abandon them.

[1] Associated Press: http://nyti.ms/2b3hFED

[2] Nick Bunker: http://equitablegrowth.org/equibableblog/did-the-great-recession-reduce-u-s-productivity-growth/

[3] https://www.amazon.com/Irrational-Exuberance-3rd-Robert-Shiller/dp/0691166269/ref=sr_1_1?s=books&ie=UTF8&qid=1470767557&sr=1-1&keywords=irrational+exuberance

[4] http://NYT.ms/1TgrJVD

[5]https://www.brookings.edu/~/media/research/files/papers/2013/3/us%20productivity%20growth%20baily%20manyika/us%20productivity%20growth%20baily%20manyika.pdf