When It Comes To China, Outside Pressure Doesn’t Work
In the frequently sad history of China’s relations with the west, the predominant narrative in the west is an often exaggerated belief in the power to influence events in China. In fact, when the west tries to exert its influence, it frequently fails. This is because of:
- The Chinese tend to be nationalist, resisting outside interference, and different Chinese governments have used that to their advantage.
- The westerners often pick the wrong horse to back, choosing the horse they like and communicates with the west better, but who is often held in disdain, even contempt, by the Chinese.
- Especially in the US, legislators and media pundits who don’t understand China try to set the agenda on China, even though they have no understanding of China. Their own PR needs outweigh the need for real understanding.
- The west emphasizes the power of the individual, while the Chinese tend to weigh the interests of the whole.
On the eve of President Hu Jintao’s visit to the US, this is made clear by Senator Charles Schumer’s promise to start a trade war with China. If Congress jumps on this bandwagon, things will get tough.
In my next article, I will talk about how the Chinese make things tough for the interlocutors.
Discussing China on Quora
With the recent test flight of the new Chinese J-20 stealth fighter, China’s growing economic influence, and the upcoming visit of President Hu Jintao to the US, 2011 promises to be yet another interesting year. In addition to writing for Forbes.com and Business Insider, I have also recently been posting a lot to a relatively new startup, Quora, which can be simply described as a question and answer startup.
I was invited to Quora (you need an email invite) in June, and started posting questions and answers. Since then, it has started to grow on me. It’s more than a Q&A site, it’s a knowledge network, and has managed to attract some serious and interesting China observers. If I can make a small claim, it was that I felt that the quality of discussion on China was not good on the Internet; the general media took a generally hostile attitude to China, then there are those in China who have had to filter their opinions because, well, they are working in China for Chinese employers, supporting them and their families. There wasn’t much of a middle ground, and there was little room for nuance. For this reason, I made some contributions to the discussions in the form of questions and answers, just to get the conversation going.
I am happy to say that I now feel some of the best discussion of China on the Internet is now on Quora, and it draws a very knowledgeable crowd, including people living inside and outside China. From reading the discussion, I think that you will find that there is a wide variety of opinions, but they do agree on some key issues.
I have pulled out three discussions which give you some idea of the level of conversation:
- What do Chinese consumer tech companies need to do to be innovative enough to compete in developed markets like the US?
- What will be the best entry strategy for a foreign-owned Internet company to succeed in China?
- Is Amy Chua right when she explains “Why Chinese Mothers Are Superior” in an op/ed in the Wall Street Journal?
The last topic of Amy Chua’s has been particularly active and attracted a very interesting array of opinions.
The two founders of the company, Charlie Cheever and Adam d’Angelo, come from Facebook and the company is backed by Benchmark. The current buzz is that the company has a valuation of US$200M.
To join Quora, you will need an email invite. If you are interested and would like one, let me know.
China’s Misreading Of The Global Economy
More stories come out every day about how China is favoring state-owned enterprises (SOEs) at the expense of China’s private sector. Every day there are stories about SOEs advancing and the private sector in retreat or 国进民退 as it is called in Chinese。Seemingly, the Chinese leadership has embraced the view that China was able to save its own economy in the fall of 2008 by rapidly injecting a stimulus package into the Chinese economy, which meant state-owned enterprises through its own state-owned banks. By doing this when the US government was not able to react so quickly, China was able to fire up its own economy and maintain production and employment when the rest of the world was left on life support.
It sounds good as a story, but is it really true? Certainly the Chinese government is doing some of the right things by getting foreign manufacturers to raise wages, but is the conclusion that SOEs are the right way to go for the Chinese economy the right one?
My argument is that it’s not; it’s actually a return to a corrupt version of Gosplan which the Soviet Union had in the 1980s, and led to economic stagnation.
But first, let’s talk about the Chinese government reaction to the Wall Street financial crisis of 2008. The conclusion which the leadership has drawn is that some companies should be “too big to fail” because they employ such huge numbers of people. Since the single overriding issue for the Chinese government is social harmony (low unemployment + less social incidents), then yes, SOEs do prevent this. But this comes at the price of business efficiency for the whole economy, since, for the most part, they are large inefficient behemoths. And because they receive money from the state-owned banks on a policy basis, as opposed to business criteria, they can continue to do so. The price China pays for this inefficient allocation of capital is high; it means that Chinese consumers have less money to spend on discretionary items, which means that consumer spending is kept artificially low. All because the government is subsidizing its own kind in the name of social harmony.
The greatest single misreading of the situation is that the Chinese government believes that they were able to act quickly and decisively, when in fact, it had more to do with the US’s decision to bail out the financial industry, and then presented the bill to not only today’s Americans, but future generations of Americans. Up until this crisis, the US had the reputation for practicing the most efficient form of capitalism, sometimes with harsh social results. More than Europe, the US has allowed new industries to replace older outdated industries. For the first time this time, the US stepped in to bail out the banking industry at the cost of the whole country. This time, the US government decided that the unadulterated version of capitalism was too much.
China didn’t come out better because of its stimulus package; it looked better because the US betrayed its own economic values and policies.
The right conclusion for the Chinese leadership to draw from the crisis would have been that the 2008 stimulus package was a necessary one-time fix to save China’s economy during a global crisis. But then expanding that to say state capitalism is the best form of capitalism for China’s situation is exactly the wrong conclusion.
Now Beijing has ended up with a bunch of state-owned enterprises at the trough talking about how brilliant the Chinese version of state capitalism is, while Chinese private-sector companies are starved of capital and cannot compete against larger SOEs. Not only that, but the Chinese leadership has bought the line, and is reselling it as some magic fix for turbulent economic times.
Pushed to its logical conclusion, China will end up with:
- Large companies which are less efficient and less innovative, just when Chinese companies need to move up the value chain;
- The most talented young Chinese will continue to emigrate because they know that China does not reward innovation and individual initiative;
- Chinese entrepreneurs will stay in China only long enough to get experience and develop their ideas, then will emigrate because they want their child to enjoy a brighter future;
- The rich/poor gap, already large, will worsen because of widespread power abuse;
- The SOEs will get fatter and dumber because they enjoy a monopoly;
- By showing that they have so much sway over government policy, they risk becoming a target for government and policy criticism, and the Chinese government will largely be seen as a shill for the SOEs;
- Needed political reforms, such as those recently mentioned by Premier Wen Jiabao, may be pushed back even further into the future;
Judging from the debate going on in China, it looks like the supporters of state capitalism want this to become a stated policy goal. If this were to happen, it would be a betrayal of Deng Xiaoping’s economic policies, which were about putting pragmatism over ideology. Putting state capitalism on a pedestal as if it were the single answer to all of the world’s economic problems would not have been a policy which he would have approved of.
If this were to happen, it would be a tragedy for China, its people and its aspirations. And for the rest of the world.
Tencent Makes Thailand Investment With Sanook.com
Tencent recently bought 49.92% of Sanook.com, a Thailand portal, for HKD$81.7 million. The 2,496 shares were purchased from Cape Town-based MIH, which owns Sanook.com and also holds 35% of Tencent. Tencent will get two seats on Sanook’s board, and will also have the right to nominate candidates for the company’s executive president.
Sanook was launched in January 2000 and provides information, entertainment, business and community sectors to Thai customers.
Tencent, which listed in 2004 on the Hong Kong Stock Exchange, has been expanding aggressively recently, making deals with Russia’s DST (Digital Sky Technologies) to expand into new markets all over the world, including investments in Facebook and Zynga, two of the fastest growing social network companies in the US. With a market cap of US$33.2 billion, it is one of the largest Internet software companies in the world, and has been under the radar of most US investors. Now though, it appears that the company is beginning to make its moves.
While the Sanook investment is small, it appears that Tencent will play a hands-on role in the management of the Thai company. Tencent started with a community tool, OICQ, which was based on ICQ. Later, it changed the name to QQ. Now, QQ has more than 600 million users in China, and is used on PCs and mobile phones.
Has China Embraced An Outdated Version of Corporate Capitalism?
As a consultant in software product development, I have followed trends not only in software development, but in other businesses as well. Software is one of those businesses which changes fairly quickly, since its main output is code. When software engineers decide to retire code or a standard, that code is said to be deprecated. In short, it is no longer supported in the current version, though it may be in previous versions. One of the major reasons for poor performance in consumer software is the support for deprecated systems and code; this causes a performance hit.
With the rise of the Internet, more service work is easily done in remote locations and time zones. This change is most common among software developers, many who work in other locations and are never seen in any office, but continue to contribute. It is also happening in the field of writing and reporting; I write for Forbes.com The China Tracker and Business Insider; but I have never stepped inside their offices. There simply is no need to.
Michael Pettis, an economist and observer of the Chinese economy, has made the criticism that China’s party, government and technocrats have invested too much in export production capacity, while Chinese consumer spending is actually shrinking as a percentage. This is all happening at a time when the rest of the world is looking to the Chinese consumer as the last hope for the global economy. Definitely, this is not a good sign.
The intrinsic problem is that China has become too dependent on its own state-owned enterprises to maintain growth and employment at all costs following the events of September 2008. Because they were so huge and had ready access to capital from the state-owned banks, they were able to keep China’s economy growing, even while the rest of the world headed into a funk. Nearly two years later though, cracks in the dike are beginning to appear.
For one thing, China’s economy has become too dependent on the large corporate enterprise. Both the US and China have been trying to do the same thing: trying to save large corporations at a time when they should be deprecated. This article from the Wall Street Journal, The End of Management, says it best:
Corporations are bureaucracies and managers are bureaucrats. Their fundamental tendency is toward self-perpetuation. They are, almost by definition, resistant to change. They were designed and tasked, not with reinforcing market forces, but with supplanting and even resisting the market.
In the US, government has become too closely aligned with the financial industry and its interests, and in China, the party exercises dominance and control of the economy through state-owned enterprises, many of which have become dependent on real estate speculation to be profitable. The WSJ article goes on further to say:
British economist Ronald Coase laid out the basic logic of the managed corporation in his 1937 work, “The Nature of the Firm.” He argued corporations were necessary because of what he called “transaction costs.” It was simply too complicated and too costly to search for and find the right worker at the right moment for any given task, or to search for supplies, or to renegotiate prices, police performance and protect trade secrets in an open marketplace. The corporation might not be as good at allocating labor and capital as the marketplace; it made up for those weaknesses by reducing transaction costs.
Mr. Coase received his Nobel Prize in 1991—the very dawn of the Internet age. Since then, the ability of human beings on different continents and with vastly different skills and interests to work together and coordinate complex tasks has taken quantum leaps.
Most of the reasons which Coase outlined for the creation of the corporation in The Nature of the Firm no longer exist. Thanks to Google and other tools, small organizations can resolve all of these issues for almost no costs at all. Isn’t it time we start thinking and talking about deprecating large corporations?
Of course, many in the US and China would argue that only a very small and select minority would be able to work on different time zones and in remote locations with minimal supervision; I would beg to differ. For many service jobs where key personal relationships are not important, this will become the norm within 20 years. It’s just that the US and Chinese government haven’t figured it out yet.
In China’s case, this change is particularly disturbing. Most outside observers of China don’t understand that the main metric which drives China’s economic decision-makers is job creation and employment, not company profitability. Recently, I was pointed to a long article by Daniel Cloud called Ghost Money. In the article, Cloud says:
Simply endlessly printing more money is more likely to lead to catastrophic failure – devaluation, inflation, default, or all three – than to any permanent rescue of the situation. That, in an open economy with large cross-border trade and capital flows, debasing your currency is not a long term solution to any real economic problem is something we’ve known for a rather long time. A one-off devaluation is sometimes useful, but the endless abuse of segniorage has not traditionally been viewed in a very favorable light. Someone will pay in the end; now we are beginning to see who it is. Anyone who holds a lot of sovereign debt is at risk of eventually discovering that it is fairy gold, ghost money, mere joss paper that didn’t ever correspond to any pile of goods and services actually available in this world. (Imagine an endless stream of ships leaving America full of cargo and returning from China empty, as if we were paying war reparations, individual Americans making terrible personal sacrifices to make sure the debt was paid…. The scenario is just so implausible.)
So what can China do? Cloud goes on:
Export-led growth works well in a world where the price elasticity of demand for the exported goods is effectively infinite, where any decrease in costs will always lead to an expansion in sales. Even in a world like that, though, sooner or later the very development it brings about will put upward pressure on export prices. So even in a world where the first condition continues to hold indefinitely, sooner or later it will be necessary to switch to growth driven at least partly by domestic demand. But large countries like Japan and China are bound to run into another barrier as well. Eventually their exports will become so big relative to the economies they are exporting to that people in those countries will not be able to afford to continue increasing their purchases of the exports at the same rate year after year. A country the size of Singapore can afford to ignore the limits of their customers’ purchasing power. But both Japan in the ‘80’s and China in the last decade found themselves having to lend their export earnings back to the countries they were exporting to, to keep the growth in exports going.
Once you get to this point, it should be obvious to the exporter that he is never going to get paid back at today’s prices. (Where would the money come from?) The importer is likely to try to avoid bankruptcy by forcing a revaluation on the exporter, which is politically easier for him than persuading his own voters to adopt the necessary austerity measures would be. The exporter, seeing this risk, will frantically try to switch over to an economy based on domestic demand. Whether or not he can do this depends on the condition of his political system.
Basically, Cloud’s argument is the same as Pettis’, that there is way too much capacity for the Chinese consumer to absorb, and if the Chinese consumer doesn’t spend, we are all effectively screwed. According to an article in the Financial Times, Chinese retail consumers are reluctant to spend. Cloud says that the only way out is for political reform to come to China.
If that is indeed the case, then the Chinese government will continue to fund Chinese money-losing state-owned companies until it can no longer do so. The Economist has a recent article on how the Chinese government has introduced a new circular bail-out for SOEs.
Hmmm. Looks like short-term thinking to me. Short-term bailouts do not resolve long-term structural issues.
For this reason, an article by Perry Link, a long-time China authority, in the the New York Review of Books drew my attention. This article was titled “Waiting for WikiLeaks: Beijing’s Seven Secrets” goes into some detail about the seven closely guarded secrets which are closely held in the party’s archives. I won’t go into detail about those secrets here, but what grabbed my attention about the leaked story was the final paragraph:
The anonymous reporter who leaked the contents of the July 21 meeting commented on a looming atmosphere of demise at the meeting. The underlying mood, he suggested, was, We had better get control of these archives, and perhaps destroy them, before a day of reckoning is upon us.
Does this sound like the confident leadership of the world’s fastest growing major economy? You can draw your own conclusions.
At the same time, there is an article in the People’s Daily titled “Chinese leaders vow to make Party affairs public”.
Hmmm. Interesting.
There is a point which western critics of China and the Chinese government have not pointed out. To a large extent, China is where it is now because it has followed the western model of economic development for developed economies, while retaining its own political system. Critics like Cloud say that this is why China is doomed to failure; it has followed the economics, but did not follow the political model.
I don’t think that it’s that simple.
The real problem in the Chinese model is an over-reliance on state-owned enterprises and since 2008, state-created employment. In fact, what the Chinese government should do is increase lending to Chinese private companies, and allow them to compete on a level playing field with Chinese SOEs. Instead, the Chinese government has focused all its attention and capital on Chinese SOEs, while pretending that the Chinese private sector doesn’t exist. At best, the party has treated China’s own private sector as the wife’s red-haired son from her first marriage.
For a long time in the US, private companies have been the main engine of growth and job creation. But unfortunately, Americans are not as good at entrepreneurship after they have been in the US for several generations. In the US, the best entrepreneurs have historically been the immigrants who have opened restaurants, groceries, laundries and other small businesses. They would then save money, sending their children to the best schools, so that they could become managers, doctors and lawyers. This has been true of every immigrant wave to the US, and is why the US is so dependent on new immigrants. Then, when their kids go into the mainstream, they become the new white-collar class of doctors, lawyers and managers. The problem now for blue collar workers, is that they look for jobs at corporations, and when they can’t find any, they go on welfare. But the problem is that the system is broken, and most state governments are broke.
Compared to the US, China is more fortunate. It has always had a large population of entrepreneurs. But many have had trouble finding capital to start their own businesses, or feel discriminated against by the government, which is why so many continue to emigrate to Australia, New Zealand, Canada and the US even though they have been able to achieve some degree of success in China. The end result is that many of the best remaining entrepreneurs are government bureaucrats, who abuse their privilege to become wealthy. Then the Chinese government goes after some of those, putting them on trial for corruption, and serving them up to the people as examples of how the government is helping them.
But doesn’t it make much more sense to help China’s own private sector by providing them needed capital for growth at critical moments? Why should China’s own private sector continue to be treated as the red-haired stepson by the government?
The best way for China to stimulate real consumer growth and spending is to remove the barriers to growth for the Chinese private sector, so that they obtain needed capital to grow at home in China. This will work much better than any slogans about Chinese global brands, innovation and creativity for large Chinese SOEs.
Most likely, these new businesses will start small. At the beginning of this article, I talked about how there is less need for large numbers of people and large corporate organizations anymore. This is what Schumpeter’s creative destruction thesis was all about.
Through its control of the financial sector, the Chinese government and party has the basic tools to help China regenerate itself more, much more, than it has up until now. It has long been my view that China is a nation of small business people, farmers and engineers. The problem in today’s China is that there is not a good balance: the engineers have too much power and influence on policy, and the small business people and farmers have suffered at their expense. The engineers are good at producing, but are less good at profitability. This has led to severe imbalances in China’s economy and society.
The Chinese government has, within its own hands, the power to unleash China’s small business sector and private entrepreneurs not only as a force for change inside China, but as a force which can change the world for the better. So far, it has not given them that power.
Historically, China has had major social disruptions when the rural and urban gap widened too much, and the rural population felt that they were ignored by the central government. The Chinese Communist Party came to power in 1949 based on widespread rural support for what was seen as a largely corrupt urban Kuomintang leadership. Yet this is what is happening now in China; except this time, the gap is widening at a much faster pace. The leak from the party archives meeting shows that the party is aware of this imminent danger at its most senior levels, yet has no way to deal with it.
Now, the Chinese government is trying to build an urban middle class while retaining a dominant public sector. This has never been done before, and the leak from the party archives meeting suggests that even the government leadership has its doubts about whether it will succeed. It is time to rebalance Chinese society so that the private business sector and farmers have a greater say in China’s future. This is all the more reason for China to build a REAL urban middle class; one which is based like Taiwan’s, Hong Kong’s and Singapore’s, on a vibrant, healthy and growing private business sector.
It is time to let a hundred flowers bloom in China’s private sector.
Commentary: Chongqing as Chicago on the Yangtze
Foreign Policy magazine recently published an article on Chongqing, Sichuan’s largest metropolis and China’s fastest growing city, as Chicago on the Yangtze. For many Americans, the rise of China, and of huge metropolises which many have never heard of, let alone pronounce, comes as a surprise.
The sad fact is that it shouldn’t have come as a surprise. The rise of China did not happen overnight. To a large extent it was planned, and in some instances, it also took advantage of circumstances. For me, this raises the bigger question of why it should come as a surprise for Americans? Doesn’t the US have a free press, and shouldn’t they know about these things? Or did they just refuse to see, being pre-occupied with other events which seemed more important at the time?
Back to Chongqing. I visited the city in 2007 for several days, and it seemed to me like a mess, growing in all directions but with seemingly not much planning. In 2008, I wrote an article which was somewhat critical of Chongqing’s chances for success. Like many fast-changing industries, it’s easy to overestimate the effects of change in the short-term, and underestimate the effects of change in the long-term when it comes to China.
In the case of Chongqing, the appointment of Bo Xilai as mayor has been politically significant. Previously, Bo Xilian had served as mayor of Dalian, where he had successfully started the modernization of that city, and was then appointed to the Ministry of Commerce, where he also had a successful tenure.
Bo’s appointment to Chongqing is politically significant because it is one of the few cities in China which does not report to its own provincial government of Sichuan; it reports directly to Beijing. Before Bo’s appointment as mayor, Chongqing had a reputation for being rowdy and corrupt, with the police in collusion with local gangs. After Bo became mayor, he brought in many of his own people, some of whom had worked with him at Dalian and at MOFTEC, and proceeded to clean up. Corrupt officials were tried, and in a few instances, executed, including the former chief of police. There could be no mistake; this was no cosmetic cleanup, this was the real thing. In Chinese politics, one of the ways a politician establishes a tough reputation is to have someone who was part of the old order tried and executed. This shows that the politician is a “tough guy” and will not compromise. Even more, it means that the corrupt old guard won’t come back, and if they try, it will literally be a fight to the death. When this happens, support for the ancien regime usually collapses.
There have also been reports that Chongqing plans to introduce a property tax, which would be a first in China. While there has been widespread discussion about the introduction of property taxes in China, it is politically difficult to do so, especially in the major cities of Beijing, Shanghai, Guangzhou and Shenzhen, which like Chongqing, are direct municipalities which report directly to the central government. Unlike Chongqing, they do not have a mayor who was given a free hand to clean up, and tried, jailed or executed the former clique which ran the city.
Bo Xilai is widely known to be politically ambitious, and there has been discussion that he may want a seat on the Politburo’s Standing Committee of the Chinese Communist Party. Looking at it now, there are two ways it could go: he may be quickly appointed to the Politburo Standing Committee and go back to Beijing, but another scenario which may be more likely is that he is being asked to introduce the property tax in Chongqing and make it a success before being asked to take a major leadership role in Beijing, which may be higher than the Politburo Standing Committee role. If Bo Xilai can make a success out of the introduction of a property tax in Chongqing, and then goes to Beijing in a major role in the central government, he would be in an ideal position to introduce the property tax nationwide.
In all of China’s cities, the major developers have a tight relationship with municipal governments, and their resistance to a property tax makes implementation virtually impossible. But Bo’s actions in Chongqing show that he means business, and that he has the team to make things happen.
In another article, I talked about how the Chinese government liked to try new policies on a trial basis. For Chongqing and Bo Xilai, it is an ideal place to try and experiment to do new things in new ways.
For businesses, it is often wise to ally politically with a rising star. Chinese pay attention to timing; it not only matters that you ally with a rising star; what is even more important is when you ally with them. Chinese government officials give special preference to companies which came to China when it was dirt poor, and when western countries had sanctions against China. These companies are generally considered to be “old friends of China” and tend to be given special preferential treatment on an unofficial basis. The later you come in, the less special you are.
If you company comes to China now, they will look at it purely in terms of how much investment money and technology you bring in, and then they will negotiate the degree of market access you get. This is of course, a generalization, but you get the idea.
The same goes for individual politicians who are rising.
The Chinese definitely prioritize their friends, and if you’re smart, you’ll know where you stand in that priority.
Podcast Interview About US, China with Eric Garland of Competitive Futures
I recently did a podcast interview with Eric Garland of Competitive Futures. Eric was until recently based in Washington DC, and recently moved to St. Louis, Missouri. His company is a strategic analysis firm which advises companies on global strategy related issues.
Our conversation was about how China sees the US, especially in the period following the Wall St. meltdown of September 2008. I’m pleased to say that the podcast has been very well received, and Eric and I have started talking about doing more podcasts about China in the near future. Please tell us if you like it, and we’ll do our best to make things happen.
This podcast can be listened to on the Internet, or as part of Competitive Future’s new iPhone app.
