Don't bank on China for the next miracle

Michael Harrison on a Japanese collapse and the West's search for a new economic star in Asia

IT IS HARD not to feel a twinge of satisfaction at the turn of events in Japan and elsewhere across Asia. Two years ago, when the first Asem Asia-Europe meeting took place in Bangkok, there was a distinct swagger in the step of the Asean leaders. Their tiger economies were the envy of the world and Europe was scrambling for a share of the miracle, egged on over here by pundits and politicians alike (Tony Blair in particular).

Now the boot is on the other foot. The 10 Asian leaders who have assembled in London this weekend for Asem 2 now find themselves cast in the role of supplicants. They complain that Europe has not stumped up its fair share of funds to bail out the likes of Thailand, South Korea and Indonesia.

They want a partnership with the European Union to foster trade and investment. But what they also want is our money, channelled through the International Monetary Fund, to put right their battered economies which, we now know, were built not on sound money but cronyism, corruption and crass lending.

Until very recently, it looked as if Japan would withstand the devastating combination of recession and deflation which has sent South East Asia into such a tailspin, even though the area is Japan's single biggest market.

Now no one is quite sure. The president of Sony, Norio Ogha, says Japan is on the verge of economic collapse and compares Prime Minister Hashimoto to Herbert Hoover, who led America into the Great Depression of 1929. Mr Ogha wants the Japanese government to reflate the economy and stimulate domestic demand (Sony finds it hard to shift Walkmans when everyone is keeping their money under the bed).

Mr Ogha's comments, given to the foreign press corps, were undoubtedly intended more for consumption in the West. If the plan was to pile the pressure on Mr Hashimoto just as his American and European counterparts are also calling for a big Japanese fiscal boost, then it could not have worked better.

But there is worse to come. Moody's, acutely aware of the failure of credit rating agencies to forecast the Asian slump, has changed its outlook on Japan from stable to negative. This is a neat way of making Japan pay more for its borrowings without actually downgrading its sovereign debt.

Meanwhile the Tokyo stock market continues to slide, which is perhaps more ominous. In the last week the Nikkei has shed another 7 per cent of its value, putting more pressure on the beleaguered banking sector which has a large proportion of its capital tied up in equities. How long before we enter the danger zone where the banks can no longer maintain their capital ratios and are forced to cease trading or seek a government rescue?

With many of the tiger economies flat on their backs and the US determined not to allow its trade deficit with Japan to grow further, an export- led recovery does not look on the cards.

Japan has implicitly accepted that its future economic success will depend on having the kind of open markets and deregulated financial services that Anglo-Saxon capitalism has pioneered. In a week when the FTSE 100 has breached the 6,000 mark and Wall Street has smashed through 9,000, it is hard to argue with the supremacy of the Western model.

That is why Japan launched its Big Bang this week, a process that could eventually see Tokyo opened up as a financial centre in the way that London was a decade ago. Since then the London market has doubled in value to $2,000bn, passing Tokyo on the way down.

A similar Japanese renaissance is not impossible. But right now it looks unlikely. That is why Western leaders are subtly shifting their allegiances towards Peking in the event that China, not Japan, becomes Asia's economic powerhouse in the 21st century.

Mr Blair has made the transfer from fan of Tiger to friend of China seamlessly, feting the new Chinese premier Zhu Rhongi as a "fellow moderniser". Asked whether the Chinese leader was the sort of man Mr Blair could do business with, Mr Blair's official spokesman replied: "Mr Blair did business with Mr Zhu."

It is all rather alarming. China may be a vast potential market with 1.2bn potential customers and a growth rate that would have made even the Tigers roar before the onset of their present troubles.

But in vast swaths of the country, China remains a feudal economy with a physical infrastructure that is at best crude and, in many areas, non- existent. For all Mr Zhu's reforming zeal it is important to remember that China is still run by a totalitarian regime.

Furthermore, it remains bureaucratic and corrupt while its banking system is not that healthy. Moreover, the pace at which economic reform is being pursued may prove unsustainable.

The Chinese state, a vast bloated bureaucracy, is seeking to reduce its payroll by the equivalent of the entire working population of the United States. Stop for a second and think of the unstoppable tidal wave of social unrest that threatens to create.

The rush of Western companies seeking to get a toehold in China is extraordinary. Airbus wants to build commuter jets with the Chinese, Rolls-Royce wants to design engines, BAA wants to run their airports and Zeneca is putting up a weedkiller plant. Everywhere you look, Western companies are looking for a slice of the action whether it be lubricants from Burmah Castrol, air fresheners from Reckitt and Coleman or condoms from London International.

Companies falling over themselves to do business with China could do worse than reflect on the experience of Richard Gosling, recounted in the columns of this paper on Tuesday. Mr Gosling lost millions of pounds in a venture with China's 14th largest state-owned corporation to build printed circuit boards in China. A High Court judgment against the corporation, CTIETCC was ignored and Mr Gosling got his money back only after obtaining an order to seize its assets in Hong Kong.

It is a salutary story which Western politicians as much as businessmen should contemplate before they embrace China as the next economic miracle, only to be sorely let down once again.