Kiwi analyst Michael Parker on why robots and modern China are ruining Adam Smith's Wealth of Nations treatise and will frustrate Donald Trump

Chinese robots appear to be bringing to an end a path of "serial industrialisation" across Asia that has run for 60-odd years, says Hong Kong-based Bernstein analyst and ex-pat Kiwi Michael Parker.

In a research note entitled Adam Smith vs Chinese Robots...The end of The Wealth of Nations, in one chart (not ours), Parker points out that instead of shedding low cost manufacturing as it develops, China is getting rid of the workers but not the work.

Parker notes that Adam Smith's Wealth of Nations, published in 1776, remained broadly relevant to capital allocation decisions globally for 240 years. Basically, if an individual, company, or country has an advantage in producing something, then the individual, company or country should specialise in producing that one thing, and trade for everything else. But, Parker, says, in recent years this concept has run into two forces that Smith could not have contemplated, being robots and modern China.

Parker goes on to say the simple path to economic development in Asia over recent decades has been to cut import and export restrictions, open up borders to foreign investment and "absorb the t-shirt, plastic toy and sneaker manufacturing jobs" from some other Asian market as the population in those markets gets richer and demands higher salaries. This has played out in Singapore, Hong Kong, Japan, Taiwan, South Korea and now China. Thus the competitive advantage has been low cost labour, and low cost manufacturing has "bounced around Asia" taking advantage of this.

"This approach has led to a path of serial industrialisation in Asia for the last 60 years," says Parker.

The end of the road is nigh

But, he suggests, the end of the road for this Wealth of Nations scenario may have arrived.

"In 2015, China spent 50% more on robots than North America and roughly three times more on robots than Japan. The number will be higher and the disparity greater this year. In short, China is taking a different approach when it comes to how to deal with the mismatch between high cost employees and low cost manufacturing. Specifically, China is not getting rid of the work (or not all of it). It's just getting rid of the workers," Parker says.

Meanwhile, Parker notes global trade by value has been falling, being down 10% year-on-year in the four quarters to June 2016. The peak was US$4.834 billion in the fourth quarter of 2013. The drop, he says, is a function largely of low commodity prices and on-shoring, whilst China is still operating a trade surplus in the vicinity of US$600 billion and remains the world's biggest net exporter.

"At the same time the t-shirt, plastic toy and sneaker manufacturing jobs are leaving China. Walk into H&M or any High Street apparel store anywhere in the world and the clothes that you will find there are all made in Bangladesh, Vietnam or Honduras. China is simply not the factory of the world anymore, or not the low value one."

"This was supposed to be the end of the Chinese economic experiment. Without factory jobs for the unskilled migrant workers, the engine within the economy was supposed to falter and growth was supposed to collapse. That hasn't happened. The simple manufacturing is moving to low cost parts of the world (as Adam Smith would have predicted), the more complex manufacturing tasks are being automated, and the workers are moving into the services sector," says Parker.

Chinese jobs in services

Parker and his Bernstein colleagues monitor the Zhaopin job search website weekly, evaluating the number of jobs available and the wage being offered in Chinese cities. Over the past year, almost without fail, he says job postings have increased as have wages. Over 12 months job postings are up 68% and the mean wage is up 4.5%.

"There are plenty of jobs available in big Chinese cities for unskilled workers at the end of 2016. Most of them are in the services sector."

This includes jobs in IT, communications, electronics, the Internet, financial services, business services in accounting and legal consulting, retail, wholesale trade, leasing, education, hospitality, beauty, nursing, health services, logistics, media, publishing, entertainment, academic and scientific research, government and non-profit.

"In short, the migrant workers are not moving back to the countryside. They are finding service jobs in Chinese cities," says Parker.

'Manufacturing activity may come 'home', but there are simply no jobs to steal'

This disruption to the 20th century pattern of manufacturing activity flowing across Asia and into emerging markets elsewhere will have some profound effects, Parker points out.

Firstly, "the best modern example of Adam Smith's argument" is going to disappear. As robots get cheaper and labour gets more expensive, the proliferation of robots in more and more low-skill roles such as t-shirts, plastic toys and sneakers, is likely to occur. And the ability of new, emerging markets to grab these jobs and the export activity that comes with them is likely to be eroded.

"The trade-off between sacrificing Chinese infrastructure for the temporary benefit of low cost labour elsewhere will militate in favour of automation and staying in China," says Parker.

Secondly, Parker notes recent election results in developed markets being interpreted as suggesting frustration among middle and lower income voters with both the Establishment and their economic lot, (think Donald Trump and Brexit).

"One means of tapping into that frustration has been for politicians to promise a return of good, well-paying manufacturing jobs to developed markets (well, one developed market in particular)," says Parker.

"However, thanks to factory automation, that outcome is barely available in Shanghai and Shenzhen, let alone Shreveport and Scranton. The promise of the return of well-paid manufacturing jobs would be economically imprudent if all we had was the analysis of Adam Smith working against the impulse. If an individual, a company, or a country has an advantage in producing something, then that individual, company or country should specialise in producing that one thing, and trade for everything else. Alberto [Moel, Parker's colleague] likes to quote Berkoff's Law: 'Science always losses to engineering, engineering always loses to economics, and economics always losses to politics.' But even that elevated cynicism is arguably no match for robots," says Parker.

"Import tariffs and quotas might serve to thwart a simple economic observation about the efficiency gains of specialisation. Before the emergence of the General Agreement on Trade and Tariffs and the World Trade Organization, countries could effectively protect domestic industry and jobs through trade barriers. Of course, in a world of low cost and adaptable robots, even the role of the humble trade barrier is up-ended."

"It is still possible to force the relocation of production through the introduction of tariffs and quotas. However, if the point of the exercise is to restore well-paying, middle class jobs in manufacturing in the process, the result is going to disappoint. Any such effort today is likely to result in greater and greater degrees of automation. The activity may come 'home', but there are simply no jobs to steal. Mandating a physical task be carried out in a high-cost labour market in 2017 is simply going to increase the chances the task is automated," says Parker.

'The age of industrialisation is coming to an end'

Parker concludes by saying the age of industrialisation is coming to an end. Smartphones and online-to-offline apps give unskilled workers options for making a living that do not involve setting foot in developing market factories, he points out. And automation is making manufacturing activity cheaper and less labour intensive. Thus income inequality in developing markets will rise when work means competing against other unskilled service workers rather than banding together and unionising.

"However, the bigger risk, as has become apparent this year, is the widely held belief that Adam Smith's 18th century observation about specialisation can be reversed. What was once bad economics and bad policy is now physically impossible. Trade barriers may respect borders. Robots do not," concludes Parker.