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November 19, 2022

Will It Happen Again? A Great Depression and Rise of the Planned Economy

During the Great Depression of the 1930s, the newly established Soviet planned economy was the envy of the world for its glorious progress. But it eventually became synonymous with political repression and a rigid economy, which collapsed in 1991, causing 6,000% inflation in two years.

The world is now about to see "Lehman Financial Crisis 2.0". In the midst of this, the masses demand distribution by strong governments and look to populist politicians. The world is about to repeat the mistakes of the 1930s: a recession and expectation for a strong government, as if it had learned nothing.

The Course of History

The Soviet Union's planned economy literally collapsed in 1991 due to the lack of innovation and accumulated budget deficits, and the market economy seemed to have won a permanent victory. Francis Fukuyama and others in the U.S. were proud of this, calling it "the end of history" and the ultimate triumph of democracy.

But now, with the end of the Cold War, China's entry into the Western economy has ironically generated troubles for both the Western market economy and democracy. The exodus of industry to China has resulted in the disappearance of many high-wage jobs in developed countries and the division of society into a handful of wealthy and impoverished masses. The impoverished are putting aside freedom and democracy and turning to populism and fascism in search of immediate redistribution.
Meanwhile, Russia and China, now in a better position, are taking steps to strengthen their command and state economies in order to consolidate their own power and to compete with the West.

The Case of Russia
It is clear by now that Russia is not fit for a market economy (on the production side); the country is now returning to a command economy. The war in Ukraine has caused a series of withdrawals by the few valuable foreign companies. Exxon, Shell, and others from the oil sector, GM, Toyota, and others from the manufacturing sector, furniture giant IKEA and others from the distribution sector, and McDonald's and others from the restaurant sector have withdrawn. The Russian companies are taking charge of the remnant taking over the rest, but they lack the funds, technology, and management know-how, so it is not clear how long they will be able to sustain themselves.

Putin has said that he will "not allow" foreign companies to withdraw from the energy sector, i.e., he will not allow them to sell their shares, which is essentially the same as confiscating foreign holdings. Foreign companies have cut their losses, pulled their personnel, and stopped providing technology, which in some places lead to a decline of oil extraction. The passenger car sector, which was heavily dependent on foreign companies, has been decimated, with production for the January-September period down 65.9% from the same period last year.

In addition, on October 19, President Putin established a "Special Coordination Committee" to increase military production. He gave it extrajudicial authority to relocate resources. Prime Minister Mishustin, who was entrusted with this responsibility, was forced to override the budget he himself had compiled (which had become law) and make arbitrary budget allocations. This will return Russia to the command and military economy of the Soviet era (over 60% of industrial production was considered military-related). Or, rather, much of the funds would be squandered and embezzled, accompanied by a competition for funds among the various ministries, central and regional.

Local coordination was entrusted to Sobyanin, head of the State and Local Self-Government Commission (and also mayor of Moscow), who is a former rival of Myshustin for the prime minister's post. This will add to the confusion.
Soaring energy prices are still supporting the Russian economy, but the cost of the war is putting the budget in the red. If energy prices collapse, the Russian economy will collapse, and its people, accustomed to Western products and Western-like consumerism, will begin to protest.

The Case of China

In China, the standard of living has improved, but the Xi Jinping administration is rushing in the opposite direction of freedom and democracy, which a better life usually brings. He is trying to remove the language of "reform and opening up," which brought about the current prosperity and the country's rise in the world, from the "Legislative Law." This Law lays down the basic principles of legislation.

When young elites were sent down to rural areas and deprived of formal educational opportunities during Mao's Cultural Revolution in the late 1960s, it was much feared what would happen when this generation of elites were placed in leadership positions. Now the fear comes true. The Xi Jinping leadership has given top priority to maintaining the Communist Party's power and has removed economic technocrats from decision making. The leadership is determined to "do whatever is wrong with the economy."

The excessive lockdown imposed by the Corona disaster has already severely hampered the economy of Shanghai and other production centers. In addition, Li Qiang, who has no experience in central government administration, will be elected premier at the People's Congress next March and is poised to take control of economic administration thereafter. His government will not be so subtle to move the economy through indirect means such as fiscal and monetary policies, but will instead develop a command economy, telling the companies what to make, how many, by when, and how many to sell, to whom, at what price etc. The same applies for foreign companies.

In the author's experience, bureaucrats in former socialist countries, even after the "transition to a market economy," routinely made requests to foreign companies regarding the amount of production and exports for the following year, and in fact gave them orders to do so.

The process, which is taking place in China now, strongly reminds me of Empress Dowager Xi Taihou, another Xi who toppled reforms by her own son Emperor Guang-xu-di in 1898. Two years later, when the people began to stand against foreign intrusion (Yihetuan Uprising), Empress Xi rode on it and declared war on the Western powers only to be crushed.

I don't think today's Xi will go this far, but something like the 2012 anti-Japanese movement that attacked several Japanese business establishments could well happen.

Can the Western economy prosper without China and Russia?

For any developed country, economic relations with Russia are marginal, except for energy resources. The impact of Russia's exit from the global economy will be limited to energy resources and some raw material sectors.
The price of energy resources will temporarily rise with Russia's exit, but this will not cause only Japanese companies to lose competitiveness. They just need to raise product prices and raise wages.

In the case of China, it is much more difficult to deal with because it has become the "world's factory. Rather than a black-and-white decision, a case by case and realistic response is required.

Some Japanese say, "Japan depends on the Chinese market for more than 20% of its exports. If this market were to disappear, the Japanese economy would not be able to sustain itself." But when we analyze what Japan exports to China, the fear will diminish a bit.

Rather than exporting finished products such as passenger cars and electrical goods, Japan exports "producers' goods" such as parts, materials, and production machinery to China. Most of these products are destined for Japanese and other factories in China, and many of the products assembled there are re-exported to Japan, the U.S., and Europe. If the assembly base is moved to a location other than China, Japanese exports will be directed there.

Secondly, there is the argument that "if China is removed, the global supply chain will be disrupted." It is true that China is the exclusive supplier of some raw materials, such as lithium. However, most of those items can be produced in other countries, though at a cost. Product assembly for Apple's IPhone, SoftBank's Pepper, etc., would be moved from China to another country. This will happen anyway, as the U.S. is about to impose strict controls on semiconductor exports to China.

Restructuring the Supply Chain

During China's 30-year history of reform and opening up, the West has created supply chains within China. It will take time to reverse what has taken 30 years. But if they remain, they will eventually be nationalized by China.

Whether it is product assembly or component production, it will not be easy to find an alternative location to China. Not just any low-wage country will do. If you want to export to the U.S., it would seem that you should manufacture in the U.S. However, if you build a factory in a state with strong labor unions, the factory will be preyed upon by labor union leaders.

Taiwan's TSCM is trying to build a factory in the U.S. at the request of the U.S., but is having trouble finding workers. TSCM is now building a plant in Arizona, where a U.S. competitor, Intel, has already set up a plant and is training workers.

Other potential sites include Southeast Asian countries such as Vietnam, Bangladesh, India, Turkey, and parts of Africa such as Kenya, but all have their own problems - difficulty in securing land, lack of infrastructure, corruption of local authorities, and inert workers. These problems require careful research, prudent decision and competent local management staff. If this is left to third parties such as consulting firms or investment banks, the project will only end up being preyed upon.

Japan's position is now clear.

In a sense, the emergence of a government like Xi Jinping's in China, which had the momentum to dominate not only Asia but also the world, is a blessing in disguise. While it is unnecessary to confront China out of hand, we have an opportunity to present to the world the meaning of Japan as a major Asian power, as opposed to Chinese-style centralization and authoritarianism.

As for infrastructure construction, Japan can use soft loans and other forms of ODA, as it has done in the past with Southeast Asian countries and China, to promote construction in a way beneficial for a partner-country (instead of trapping a partner in a debt trap, as China has done). It is imperative that all of Japan, including politicians, bureaucrats, and academics, make a concerted effort to convey the message that Japan is a bastion of democracy and free economy in Asia.