Friday, March 01, 2013

The China Debt

The Wall Street Journal has an interesting article up this week, about the coming Debt Crisis in China.
Mr. Sharma appears to have the credentials to speak on this, not only in his role at Morgan Stanley, but also as a published author on national economies.  Forbes also had a recent article about China’s debt,
with similar warnings although somewhat less dire.  I found it interesting from a personal perspective, because it echoes impressions I received in my own, admittedly amateur, consideration of the situation.   
To put it bluntly, everything has to be paid for by someone.  There may be such a thing as a free lunch for you, but only if you get someone else to pay for it. This is where all risk consideration starts, the fact that someone has to pay for things and by definition if you are involved in a transaction with someone who may not pay, then you are at risk of paying for something used or taken by someone else.  As a credit manager, I am well aware of customers who aren’t good credit risks, and it should really not be a shock to consider that most governments are none too trustworthy on that count.  After all, most government contracts of which I have been involved in or knew about, involved poor performance by the government, in many cases because the government is well aware that you can’t do much about it if they pay slow or give themselves discounts not allowed in their contract.  What are you going to do, after all?  Sue them?  Give them a bad credit reference?  Actually, there are reasons that the government ought to be better at paying its bills, but that shows up only at the high level consideration.  If the government fails to pay in a reasonable time to its suppliers and service contractors, those companies will stop doing business with the government, out of a need to survive as much as anything else.   But in the short term, governments tend to be poor-performing customers. 

And as you might guess, in a government which is based on both a single political party in a strong central government, and an economic philosophy that the people have no individual rights, government spending is unlikely to be criticized at all, let alone challenged.  So China has basically done whatever it pleased for the last sixty-four years, with sometimes disastrous results.  They seem to have good intentions this time, building roads, bridges, and power plants for infrastructure, but they have planned no better for this than they have anything else in their past several decades.  The problem is that basic question of how they pay for the things they want.

 President Obama made many blunders in his first term, largely because he did not understand how things work, nor did he really seem to care.  It should be obvious that throwing trillions of dollars around is bound to have an impact, though it will do more damage than good if you are not very careful with it, since all that money comes from the wealth of the nation.  Too much spending by a government is, in essence, eating your seed corn and dooming the future.  But at least in the U.S. there is the potential for an elected official to be held accountable for his decisions, and for all the gloom and doom from the media, the U.S. is far and away the most productive nation on the planet.  China, on the other hand, is not equipped to handle a debt crisis, neither on the political front nor in economic terms.

The political dimension for China would seem to be apparent. The problem is that following the Sichuan Earthquake, China found itself facing serious criticism for the failure of basic systems and the deaths of children and elderly people.  On the surface, China handled the crisis much the same as they have addressed previous disasters, but there are indications the Central Committee demanded more than face-saving gestures this time, in part due to the sense in many parts of the country that coastal regions have received much better capital support because of foreign investment and China’s high-tech PR spin, while rural and highland areas have been ignored, to the point that lives have been lost.  To allay these rebukes, China’s Politburo has spent unprecedented monies on infrastructure, especially roads, bridges and construction of housing.  Funding for high-profile projects (such as aircraft carriers, a China-only hypernet system, or new resort communities along the east coast), however, has not been changed, so China is spending money in larger amounts than it can justify in the long term, partly because neither alternative is politically palatable.  While unthinkable in the West, the potential for catastrophic events like a civil war or a military coup attempt have been quietly voiced by intelligence analysts, possibly as soon as 2018.

The economic facts are even more harsh.  The WSJ article noted a figure of $2.7 trillion budgeted for these projects in FY2013, which is roughly comparable to the entire federal budget for the United States, a nation which has the GDP to support most of such spending.  China, bluntly, cannot come close to producing the revenue needed to support such spending.  China’s GDP is still about half that of the US, and that does not even consider the purchasing power of the two currencies.  China, essentially has built its economy with a combination of sound principles and financial tricks.  The most obvious of those tricks would be the combination of China’s tight controls to keep the RMB low and to manipulate all financial data sent outside the nation.  To truly compete for global economic domination, China would first need to either embrace GAAP or a similar international accounting standard, then create effective internal controls statutes, instill transparent reporting practices in its public markets, and then – only then – could China hope to present its products and services with a reasonable expectation to challenge the US, Europe, Japan, or any other established major economic power on level ground.  It is, essentially, impossible for China to do so and continue to operate as a Communist regime, not least because the central government would face the irreducible conflict between state control of information and  power, and the necessary decentralization required for a national economy to be truly responsive to economic opportunities and dangers.  China 2013 is no more prepared for the global arena than Russia was in 1985.

The short explanation is that there will not be a soft landing.  When China realizes its debt cannot be hidden or simply transferred to perceived ‘wealthy’ businesses or citizens, probably between 2015 and 2017, the crisis will be sharp and almost certainly lead to bad decisions, like the initial 1997 decision to punish Hong Kong with debilitating tax rates.  Hong Kong is again likely to be hit with high tax rates on everything Beijing thinks it can charge, but this time Shanghai and other major coastal cities and regions will also be hit with taxes and sanctions, as punishment for non-communist behavior in creating business opportunities.  Companies may expect to see a streak of nationalizations, especially if the business engages in any technological industry where intellectual property is a major part of the company’s competitive advantage.  While a return to the Cultural Revolution of a half-century ago may not occur, a similar desire to punish the ‘greedy Gwai-lo’ is certain to show up again, especially when China experiences sharp inflation and high unemployment, which will be the hallmarks of the debt crisis.     

Sunday, February 24, 2013

The Performance Review

There are good ideas, bad ideas, and good intentions which don't work out in the real world.  An example of the third type is the Annual Performance Review.

Most medium-to-large companies try to operate as meritocracies.  That means they generally want to promote and reward the best-performing employees.  The problem is how to identify the best  and worst employees, and how to identify problems and areas of possible improvement.  As a concept, the annual performance review serves to identify employees who should be terminated, given remedial training, considered average, rewarded for superior performance, or groomed for executive futures.  In practice,  it just doesn't work out well.  This post examines the reasons for that disparity.

The first mistake is how companies define job performance.  Reviews basically come in two flavors - the personal opinion of direct superiors, or a standard form used as a rating system, again primarily judged by the direct superiors.  In both cases the judgment of managers can be far too subjective a measure, and the standardized review form is often biased by focus on certain qualities which may be easier for some employees to demonstrate than others.

To make matters worse, many managers are focused on key group performance metrics, making it difficult to track individual performance, especially since individuals are not always able to demonstrate empirical results.  And if that were not enough, most HR departments seem to set deadlines for turning in evaluations which don't give managers enough time to really do much thinking on their grades, especially since managers still have to do their regular jobs and meet their deadline for work and reports.

But it gets worse.  Most companies want employees to write up self-reviews, then managers need to write up their own reviews, get them approved by their superiors and HR, then meet with employees to discuss them.  Again, as I said, while still doing their regular duties with no time or resources set aside for the reviews.  It's not hard to see how doing the performance reviews will, in fact, hurt actual group performance/

Another problem is the scoring of reviews.  Rather than just allow managers to say whether someone is dong a good job or not, most HR departments require managers to score employees on a wide range of categories, supporting with examples and comments.  This just makes it harder for managers to identify and reward the truly exceptional employees, because managers have to spend same amount of time and effort on every employee, and even exceptional employees can come off as just slightly-above-average if they are graded on qualities not essential to their job along with those which do matter.  The weighting of categories is another blunder.  Just ask any department or group manager if they were asked about the ways their employees should be judged, about the competencies which should be used to grade how employees perform, and you'll hear that HR never asks for opinions from the people who best understand what competencies should be measured, and how they should be identified.

I'm fifty-two years old going on fifty-three, and I have never come across a performance review standard that was anything but a waste of time.