TightWind is written by Kyle Baxter. Stay Hungry. Stay Foolish.

David Leonhardt:

To continue growing rapidly, China needs to make the next transition, from sweatshop economy to innovation economy. This transition is the one that has often proved difficult elsewhere. Once a country has turned itself into an export factory, it cannot keep growing by repeating the exercise. It can’t move a worker from an inefficient farm to a modern factory more than once. It cannot even retain its industrial might forever. As a country industrializes, workers will demand their share of the bounty, as has started happening in China, and some factories will start moving to poorer countries. Eventually, a rising economy needs to take two crucial steps: manufacture goods that aren’t just cheaper than the competition, but better; and create a thriving domestic market, so that its own consumers can pick up the slack when exports inevitably slow. These steps go hand in hand. Big consumer markets become laboratories where companies know that innovations will be tested and the successful ones richly rewarded. Those products can then expand into countries with less mature consumer markets. Look at the telephone, the personal computer and the iPhone and iPad, all of which were designed in the United States and are now sold around the world.

Fabulous piece by Leonhardt for the New York Times. Send it to Instapaper and read it all when you have the time.

China’s development, thus far, has been based on an abundance of cheap labor. This has allowed China to become the world’s factory, manufacturing goods for sale in other countries. But as Leonhardt so nicely explains, you can only gain economic efficiency by transferring a worker from farm to factory once.

There’s two pressures working against China’s cost advantage. First is supply—soon, they will run out of new workers in the east, and companies will have to move west. This is already happening, with Foxconn doing just that. On the face of it, this sounds like a good solution; the west is undeveloped and full of people yearning for better paying work, but the problem is that China’s west is landlocked. Manufacturing goods in the west, unlike manufacturing near the east’s ports, requires moving them to port using comparatively expensive rail or truck. The west will never be the panacea China experienced in the past few decades. This will force companies to pay higher wages. Megan McArdle, who just traveled to China, says she’s heard labor costs rising by fifteen to thirty percent in major urban areas.

The second pressure is changing expectations. As more people move into the middle class, or just begin to move toward it, they are expecting higher wages and better treatment. A strike by workers in May at a Honda transmission factory in southern China reflects this.

This means that, at some point in the coming 10-15 years, China must transition from an export-dominated economy to a consumer-based one. This is a difficult shift, but it must happen. Leonhardt explores how the Chinese are trying to do so—by laying the foundation for a better-educated populace and by encouraging creative thinking and developing new ideas.

What should concern China just as much as their lack of innovation is that China is very much two nations. When I visited eastern China in 2008 and 2010, what struck me the most was how much it felt like a developed nation. We often hear how poor China is, but you wouldn’t know it from visiting cities in the east. Beijing’s, and especially Shanghai’s, streets are filled with nice cars and the sidewalks with well-dressed people shopping, lights and billboards everywhere. This isn’t limited to the largest cities, either.

But China is a poor nation. While the east is relatively well-developed, the west is very poor. In this sense, China is, increasingly, two nations, east and west, rich and poor. China’s great challenge, then, is not just to transition from a manufacturing and exports economy into a consumer and innovation economy, but also to bring development to the west as well. China’s west is already the source of most of the country’s instability, so this poses a catch-22 of sorts for their leadership: first, instability makes it even more difficult to bring companies (and thus jobs) westward, but it also means they need more economic growth to quell anger.