At the end of the Second World War, Germany was an “emerging market.” It was industrializing rapidly and producing brisk economic growth. Today, Germany is a mature “developed market” that grows slowly if it grows at all. Today, China is the new Germany. The industrial dynamism that produced Germany’s post-war success is moving to the East…piece by piece.

The Ruhr Valley was the heart of Germany’s industrial might. For more than 200 years, the smokestacks in this northwest corner of Germany pounded out the steel and iron that would form the backbone of the nation’s industry. And when the war drums rumbled, these factories supplied imperial Germany with its field guns, armored tanks and shells.

Prosperous communities grew up around these old blast furnaces and mills. People took pride in the stuff they could make with their hands. Tens of thousands found work in the factories of the Ruhr. Generations passed with the knowledge that their sons and daughters could make a life here and carry on the legacy of such a place. For a long time, that was the way it went.

But the winds of change patiently grind away at even the most impressive of advantages. In the early 1990s, the industrious workers of Asia powered the mortar and pestle that would crush the Ruhr’s traditional way of life.

It was a slow process, but the endgame was not hard to see. While the South Koreans became the most efficient producers of steel in the world, German workers were agitating for a 35-hour workweek. While the Chinese worked all day in their mills and new factories sprouted up like spring peepers all through China, Germany increased taxes and expanded its bloated government programs.

By the turn of the millennium, no one could ignore the stark reality any longer. The mills and factories of the Ruhr started to close — forever. In his terrific book, China Shakes the World, James Kynge tells the story of ThyssenKrupp’s steel mill in Dortmund, one of the largest in Germany. The Germans called it the Phoenix, inspired by its rise from the ashes of bombing raids in World War II.

Within a month of ThyssenKrupp closing the mill, a Chinese company bought it with the idea of disassembling the entire mill and taking it to China, near the mouth of the Yangtze River. Soon after this Chinese company bought the mill, 1,000 Chinese workers arrived in Germany to begin the process of taking the plant apart and bringing it to China. The Germans got an up-close lesson in why they could not compete. The Chinese worked seven days a week for 12 hours a day. The Germans started to complain. So the Chinese, in deference to local law, took one day off.

In the end, the Chinese dismantled the mill in less than one year — a full two years ahead of the time ThyssenKrupp initially thought it would take.

When the Chinese departed, they left the makeshift dormitories and kitchens they occupied for a year neat and clean. There was, however, a single pair of black boots left in one of the dormitories. The boots carried the brand name Phoenix, which was the same name of the plant the Chinese just took apart. The boots also carried the label “Made in China.” Kynge writes, “Nobody could tell, however, whether the single pair of forgotten boots was an oversight or an intentional pun.”

Over 5,000 miles away, the Chinese rebuilt the steel mill exactly as it was in Germany. As Kynge writes: “Altogether, 275,000 tons of equipment had been shipped, along with 44 tons of documents that explained the intricacies of the reassembly process.” Doing all of this was still cheaper — by about 60% — than building a new mill. Plus, in China, the demand for steel was such that the mill could start producing steel immediately at full capacity.

As recently as 1975, China’s entire output of steel could not match this one mill in Dortmund. Now, the Dortmund plant itself stands in China. And in Germany, you have a dying industrial city, unemployed steelworkers and the scarred earth where the mill once stood. Germany is thinking of turning the site into parkland and perhaps creating a lake and marina. But as one burly steelworker says in Kynge’s book: “Do we look like yachtsmen to you?”

This remarkable vignette captures, on many levels, how the game has changed. Comfortable workers in the factories and mills of America and Western Europe have no idea what they are up against. Even so, the nature of global competition keeps shifting. We tend to think of emerging markets, such as China, as occupying a place down on the food chain of the global economy. We tend to think of these places as sources for cheap labor and natural resources. But more and more, these emerging markets are home to world-class companies in all kinds of industries.

This is the thesis of Antoine van Agtmael, author of a new book called, The Emerging Markets Century. Agtmael is the man who coined the phrase “emerging markets” to describe growing, but less-developed economies such as China, India, Brazil, Argentina, Mexico, Thailand and other places. Before him, we called these markets “third-world” — which brings to mind many negative associations. To sell the idea, Agtmael came up with “emerging markets.”

I saw Agtmael give a presentation in Washington, D.C., one evening. I’ve also since read his new book. Agtmael spent 30 years in these kinds of markets. “I have helped IranAir lease airplanes and hire crews in Ethiopia, was involved in financing Ghana’s cocoa exports,” he writes, “and grew wise to the ways — many of them laughably one-sided — that developed nations interacted with what were in many cases recent European colonies.”

Agtmael selected 25 companies to profile in his book. All of them exemplify best practices and are widely recognized as leaders in their industries. All of them call an emerging market home.

Agtmael writes about spending time in High Tech Computer Corp.’s research lab in Taiwan in 2005 and how “Suddenly, my BlackBerry looked like a Model T.” He writes about how the regional jets we fly are made in Brazil (by Embraer). How computers are now not just made in China, but designed there. How Indian and Slovenian labs produce proprietary new drugs. And on and on it goes.

The world has changed in a profound way, but the typical investor probably doesn’t appreciate this fully. One more nugget from Agtmael: In 1988, when he started his fund, there were only 20 emerging market companies with sales of more than $1 billion. Most of these were banks or commodity companies. (Overwhelmingly, they were located in Taiwan.) Today, there are over 270 companies with over $1 billion in sales, and 38 with more than $10 billion.

Many of them are high-tech companies or provide consumer products and services. This bolsters Agtmael’s point that many of today’s emerging market stars do not rely on cheap labor, abundant natural resources or protective government policies. Instead, they have developed competitive advantages in technology, design, logistics and other areas.

Agtmael also gives his tips for investing in emerging markets. The most important of these may simply be this: “Don’t be afraid to invest in them.”

Regards,
Chris Mayer
June 3, 2008

Emerging Economies was originally featured on Whiskey and Gunpowder

It is no secret that the U.S. is currently operating under a trade deficit with China. As it stands right now, the U.S. imports $202 billion more than it exports from China. There are several intrinsic reasons for the deficit. The population of China is more than four times that of the U.S. That means that China has an overabundant work force.

China also does not have the wage controls that we are used to in the U.S. Over 100 million members of the Chinese labor force live in rural areas and are forced to commute to industrial areas and compete for factory work. This drives the already low wages down even further. The cost for companies to produce their products can remain much lower compared with those costs in the U.S.

American consumers have fallen in love with the influx of cheap products that continue to roll in from China. This has added to the great demand for Chinese-produced items, which has energized China’s once Stone Age economy. With the economy in full swing, China has been able to become the industrialized and modern nation that we have seen.

A Growing Concern — Paying the Price for Success

This kind of growth does not come without a price. With the rise in the industrialization of its factories and other means of production, along with general and sweeping lifestyle changes of its population, China has now become one of the leading consumers of foreign oil. This is straining the already dwindling world oil supplies, while sending the global costs skyrocketing past record highs.

China also does not pose strict environmental and pollution restrictions on its manufacturers the way we do. This only adds to the ease and affordability of Chinese production, while doing nothing to curb the use of fossil fuels and other polluting energy sources.

The problem with China’s overuse of energy has many components. Chief among them is the ongoing free-rider problem that has come no closer to being corrected: Individuals receive all the benefits of cheap energy while paying almost none of the cost. While one individual or firm can do little on its own to correct the free-rider problem, the Chinese government is doing even less.

Due to the rising economy, China is going through a period of rapid and unpopular inflation. Prices of almost all other goods, which used to be fixed by the government, have now been set free. In order to pacify an unhappy population, fuel and energy prices have remained fixed. The price of gasoline has not risen since May 2006 and remains one of the least expensive across the globe. While the United States is taxing its population’s fuel consumption, China’s is being subsidized.

Also aiding the inexpensive fuel in China is the fact the fuel costs are in American dollars. As the strength of the dollar falls, many Asian currencies are on the rise. This gives China an even greater purchasing power for its fixed-priced fuels. These practices are doing nothing to force any sort of efficiency or conservation onto the general population. Fuel is being consumed at increasing levels and there doesn’t appear to be an end in sight.

How We Hurt Ourselves

We see how these problems negatively effect fuel consumption and pollution in China, but we also see something very telling right here. It seems that U.S. environmental and trade policies do not act independently of each other. This should lead us to examine our current policies and see how they are or are not working.

As mentioned before, current restrictions on American manufacturers reduce output and raise consumer prices. The purpose of these restrictions is an attempt to keep the output of pollution down. The government does this because of increased pressure from environmental groups.

The government also poses energy regulations on manufacturers. This is done in the form of taxes and other restrictions. Besides the environmental reasons for limiting energy consumption, we are also facing a time of unparalleled energy use, and much of our supply of these natural resources is running out.

The government is attempting to limit pollution by thrusting these laws onto manufacturers, yet the regulations do little to curb usage. If anything, the demand for energy is just being moved across the globe. Factories in China are able to more than make up for the amount of production that is being lost in the U.S., and that does little to help the environment. The price is being paid by the American worker.

The U.S. also allows a great amount of freedom in regard to its trading practices. The problem is, as long as trade with Chinese and other foreign companies is allowed to continue relatively unabated, manufacturers here will never be able to match the inexpensive prices set by their foreign competitors.

Our environmental practices are doing little to cut down on energy usage, and the U.S. is being priced out of many sectors of the market. It looks as if either environmental laws or trade laws — or both — must be fixed in order for American companies to have even a chance to compete.

Until next time,
Jamie Ellis

October 25, 2007

The China Syndrome was originally featured on Whiskey and Gunpowder