With the increased strain in China’s relations with the west, and the west’s reliance on China for both raw materials and technology, many in the west have belatedly recognized that from China’s point of view, the west is, at best, only seen as an export market for China green energy goods. From rare earth production to processing and manufacturing of finished goods, China intends to dominate the value chain.
Funny how this largely happened without most in the west noticing it until it was too late, isn’t it?
Now, Molycorp Minerals in the US is attempting to raise more than US$500 million re-open a mine which was used up until the early 1990’s and then was shut down for environmental reasons. Part of the irony of rare earth mining is that it uses hydrochloric acid and other hazardous materials to separate the rare earth oxides out of the soil. So the process used to get these materials used in green energy are not environmentally friendly at all.
For these reasons, the US decided to outsource this environmentally hazardous mining to China, which did not have these qualms at the time. And China has leveraged that it into a trade advantage with its tight control over rare earths. In fact, North America could be completely independent of Chinese supplies if it opened a few North American mines. This is a classic case of how Chinese leadership in a sector was ceded to China by dumb policies. (Sorry, there is no other way to describe them. The Chinese just took the opportunities which were presented to them.)
The big question now is whether Molycorp will be able to raise the money needed to re-open the mine? If it is successful, it will be a sign that the US is serious about getting back into the game, and not letting China have a complete monopoly on rare earths. If it is not successful, it will send a signal of weakness to the Chinese, making the Chinese think that it is all just talk.
Let’s hope the US doesn’t send the wrong signal.
Last week I was interviewed by Chris Myrick for an article on Google in China for Wharton. The article was translated into Chinese and titled “谷歌中国新动态：胜利，失败还是僵局？” I am quoted in the article.
You can read the article here.
If you are interested in learning about China blogs in English, please listen to this week’s Sinica podcast, you can listen to it here. I am mentioned in it.
The past decade have seen the rise of many Chinese Internet companies which have become wildly successful, and which most in the west are only now beginning to notice. These are companies with names like C-Trip, Shanda, Tencent, Alibaba, Taobao, Baidu just to name a few.
For the consumer-facing companies who benefited from China’s rapidly growing consumer spending power, this growth was unrivaled. They rode two waves to maximum advantage: the popularity of tech among Silicon Valley venture capitalists and private equity firms, and with the Chinese government; and with the rise of China’s urban middle class. In contrast to many American firms which really did invest in significant technology, many of these companies had less in terms of technology; preferring instead to spend their investment money on hiring people and building a human salesforce. C-Trip, the popular travel site, was mainly a call center with a website when it went public; Baidu built up a network of resellers which it bought out when it went public, and Alibaba has an aggressive salesforce to work with Chinese SMEs.
Over the next ten years, there will be dramatic changes. Here are some of the trends I see:
- Growth in the economy will slow gradually at first, then will become more dramatic. The Chinese economy’s period of rapid growth has already passed its peak.
- Slower growth means that income gaps will widen in the society, along with opportunity gaps for individuals. From a marketing point of view, segmentation becomes more important. Qualified lead-generation businesses will become lucrative.
- As the economy slows, targeted advertising will become more important for the Chinese Internet. Advertising-based Internet models which did not work well in China previously but worked well in the west will be re-introduced into China. Successful companies will adapt them to the realities of the China market without trying to force a western model.
- Because of the slower economy, real technology adaption will take place in medium- , and even small-sized, firms. These will focus on working with very large datasets and data mining, and will focus on describing the topology of the Chinese Internet in a way so that other businesses can use this data.
- Lower disk space and bandwidth costs will mean that even though Chinese companies adopt more technology, their costs will be lower.
- From a venture capitalist’s and private equity investors point of view, the biggest cost will be the founding team. The best teams will be few and far between, and will be much sought after. Compared to Silicon Valley and the rest of the world, Chinese Internet startups will still be more likely to be led by individual entrepreneurs than by founding teams in the western mold. This is a culture thing.
- The trend to Chinese government preference for RMB funds and local investors over US- and western-based venture capital and private equity funds will pick up pace. The more unfavorable the economic environment becomes, the more dramatic action the Chinese government will take. This will cause some tension with the US, but the Chinese government will be willing to take the hit because domestic concerns for social harmony take precedence.
- Some western venture capital and private equity firms are studying the possibility of Chinese IPO exits. Don’t hold your breath waiting for these to happen; they are likely to be few and far between.
- Hong Kong will gain some advantage because it policies are different from Beijing’s and like China, smart entrepreneurs will look for opportunities in the long tail instead of the large consumer market.
China’s economic development so far is based on two assumptions which will come under pressure over the next decade. The first assumption is that rapid urbanization is a good thing, since that will lead to the development of an urban middle class. The challenge over the next ten years will be how to find jobs for that urban middle class, whose living costs have gone dramatically higher, while the global macro climate has dramatically worsened? This is already showing up in the rise of the ant people, educated white collar workers who cannot make it up all the way to the top of the pyramid. For the first time in its history, the belief that education is the path to success in Chinese society will be challenged.
The second assumption will be a shortage of blue-collar factory workers, which has already begun to show up in southern China in the form of strikes and slowdowns at foreign-owned factories. As China’s working population dramatically ages over the next decade, this situation will worsen. Technology can, to some extent, ameliorate the labor shortage, but it cannot generate demand.
During the next decade, we will find out if China can become rich, on a sustained basis, before it grows old.
If the Chinese government does not succeed, then China will head into a prolonged economic slump after 2020, which will be much like Japan’s, and further adding to what is likely to become a prolonged global economic depression. In addition, the workforce which starts working after that year will have to deal with a worsening environment and dues, in the form of non-performing loans (NPLs), from spending in the high-growth years.
That is why this next decade is make-or-break for China.
In China, the Chinese government is obsessed with maintaining economic growth at a high level. This is because a large part of the Chinese government’s implicit mandate with the Chinese people is guaranteeing continuing growth, which leads to a better standard of living. If growth slows down, then the whole basis of government legitimacy is challenged. This is why leading economists such as Michael Pettis, a very astute observer of the Chinese economy, believe that the Chinese government will continue their outbound investments in the US, for example.
Now for many other political observers of China, there is the widespread belief that Internet censorship is a human rights and free speech issue only, and something which is unrelated to economics. For them, this is an argument about humanitarian values which should be shared across the world. In the past few days, there has been a new crackdown on Twitter clones and some outspoken blogs in China have been deleted, according to this story in the Washington Post.
But what if economic performance and Internet crackdowns are in fact related, because the government fears outspoken criticism if economic indicators are much lower than the goals they have committed to and seek?
If that is the case, then the internal economic numbers which the government is seeing are a better indicator of how the people feel and will behave in the short-term, and bad numbers would make the government want to crack down pre-emptively, heading off potential dissent before the news becomes widespread.
When you put this into the Chinese context of domestic politics, and see that the Chinese leadership will be handed over to a new president and premier in 2012, what is happening on the Internet makes perfect sense. The current leadership of President Hu Jintao and Premier Wen Jiabao are due for retirement then, and will hand over leadership to a new leadership team. With two years left in their term, it is safe to say that world markets look unstable, with another wall of debt about to hit the US and Europe in the next year, further dampening consumer spending in the west. How can they manage a smooth handover without things getting unstable?
In China, there are early signs that there is an excess of white collar workers in the cities, and a shortage of blue collar workers in the factories, which is why factory workers have the leverage to slow down work or even go on strike. The traditional Chinese view of education is that the more educated you are, the better, but this view is being challenged now, and this view will sharpen over the next decade. China’s urbanization will mean more white collar workers will be looking for work in the cities, and they will have a harder time finding jobs. At the same time, this under-employed workforce will be aging quickly. Already, there are signs that a new subclass, the “ant people” are emerging, living in separate gated communities. Will this turn into China’s version of Brazil’s notorious favelas? This is the exactly the kind of situation the Chinese government wants to avoid. The gap between the urban rich and poor will become more marked.
As growth slows, the greatest challenge to the government will become readjusting the hopes and dreams of the Chinese people to a new reality of more moderate growth. This is an unprecedented challenge.
Is this a formula for social instability? You bet!
And where will they vent? On the Internet.
How will they potentially organize by spreading inflammatory remarks? On the Internet.
Seemingly this is a China problem, but as the world economy slows down, it will become a problem for other governments too. Free speech is taken for granted in good times, but in hard times, when social stability is at stake, it becomes another story.
New Goldman Report: iPad to Take Significant Netbook Market Share And More About iPhone Antenna Issues
In a new report, Goldman Sachs says that the iPad is poised to take significant netbook market share because of the five Cs: consumption, content, connected, constant operation and commerce. You can read all the details at this report on the Financial Times.
If you have been a reader of the China Vortex, this would come as no surprise, since we predicted all this about the iPad way back on January 5, before even the iPad name was announced. When AAPL was trading around $215 per share, compared to today’s $252.73.
Or you could have listened to us in March 2008, when Apple announced the iPhone SDK and China Vortex predicted that it would be a game changer. Back then, Apple shares were trading around $130 per share.
Today, the Microsoft CTO Kevin Turner predicted that the iPhone 4 may turn into Apple’s Microsoft Vista because of the antenna issues. Aside from pointing out that Kevin obviously does not come from a PR background, I have been asking myself a question about the antenna issue.
The question is this: “Why isn’t the antenna issue bigger than it is now?” While some have called for a recall, the demand for the iPhone 4 continues. Why?
My answer: “People aren’t using it for voice calls much anymore.”
The main function of the iPhone 4 is as a data device or computer, not as voice phone. The heavy data usage stats for the iPhone and iPad show that these are devices for asynchronous data consumption, not voice communications. If the primary function of the iPhone 4 was as a voice phone, then yes, the problem would have been much more serious, on a level with Toyota’s recent brake problems.
It’s called an iPhone, but the voice phone function really isn’t that important.
In my recent article for Forbes.com The China Tracker, “Apple, Google To Battle In China”, I predicted how Apple’s iPhone would be much more profitable than the Android platform even though unit sales would be lower.
This view is corroborated by this chart (second on the page) posted on Business Insider, which is now capturing close to twice the profit of the rest of the industry combined, even though unit sales numbers are only 3% of the total market sales worldwide.
I expect these numbers to be similar for the China market, and they show why Apple will be in a virtuous cycle in the China market, since iPhone and iPad sales will drive increased marketing expenditure in China, putting extreme pressure on Apple’s competitors in China.
Virtually all westerners, and most western companies, embrace the belief that information should be free. This means that it should freely cross national borders and be accessible by anyone with a browser. In short, as long as it sits on a web server, it should be accessible from anywhere.
Some individuals, such as Mark Zuckerberg, Facebook’s CEO, and Google’s CEO, Eric Schmidt, have gone so far as to embrace the concept that people should have almost no secrets at all, and that if you do have secrets, you are either backward, or have something bad to hide. Basically, they put forward the view that if you want to hide something, you are old, out-of-date and out-of-fashion, and that you SHOULD embrace openness as the way of the future. Mark Zuckerberg has gone so far as to say that if he had the chance to re-architect Facebook all over again, he would make it completely open, with no privacy controls.
Many in the west, especially libertarians, have embraced this idea without even debating the merits of this argument. People in the IT sector especially are sympathetic to this POV, so much so that it has become a white god. The white god syndrome is the widespread belief is that those in the west have always known what is best for the rest of the world, and that it upholds the precious values of personal liberty and individualism. After all, hasn’t the west been the leader in the struggle for human liberty and progress, fighting two world wars and numerous small wars so that others could be free? Many in the west adhere to this point of view, forgetting to question why accountability in the west is often applied selectively, in spite of all the claims made by its proponents.
If you accept this historical narrative, then anyone, or any government, which dares to object are either ignorant or evil.
Throughout the argument for free flow of information, there is no room left for defining the role of what a government does. There is only 1) information and 2) the rights of the individual to access that information anytime and anywhere.
Because the argument is framed this way, the Chinese government’s claims for Internet sovereignty have been met with derision and even contempt by the western press. The Chinese government’s claim is simple enough: IT companies in China must adhere to PRC laws. Looking at it from the surface, there is nothing revolutionary or different about the PRC claim; other governments, including those in the west, require IT companies to follow the laws of the country they do business in. If there is a difference in China, it has to do with due process, and what the government needs to do in order to obtain data from the IT companies. This is where things get blurry.
The infrastructure for the Internet was built in a way which did not clearly follow national borders. A US IT company may have web servers in Iceland, which now has the most stringent laws protecting data privacy. The data may or may not sit on the company’s own web servers; it could just as easily sit in the cloud, on servers provided by Amazon, Microsoft, Google or Apple, adding yet another layer of abstraction. Just thinking about the legal aspect of this is likely to throw lawyers into a tizzy of billable hours.
In contrast to this, the Chinese government has been very protective of Chinese consumer data. In China, consumer market research is a restricted industry, meaning that non-Chinese market research companies are not allowed to enter the field. In order to enter the industry, most western market research firms need to form joint ventures or partner with multiple Chinese market research firms. While the western market research firms do the analysis, the data is usually kept in the hands of the Chinese market research firms. This way, the data about Chinese consumers is always kept in the hands of the Chinese market research firms, and never leaves China’s borders.
The only exception to this rule comes with regard to personnel files in western multinational corporations. Most US and European firms have centralized HR departments at company headquarters; these include detailed personnel files for all staff and management, regardless of country and location.
Throughout this discussion, it has become very clear that the Chinese government does not adhere to the currently dominant western notion that information should flow freely across borders. This position has been made crystal clear in the showdown between Google and the Chinese government over censorship. I see the Internet sovereignty assertion as the first step in a systematic pushback against the free flow of information argument.
How could the Chinese government push back further? The simplest and most logical argument would be to claim that all personnel and data files on PRC citizens must not leave the PRC’s borders, and giving the security services the right to go to western MNCs’ HR departments to perform data audits to make sure that they are in compliance. Such a move would throw their HR departments into chaos, as it would mean that headquarters would no longer have the personnel files of PRC employees.
If the PRC government were to make this claim, it would effectively claim that it has control over all data about its citizens.
To sum up:
- There should be a healthy debate about the free flow of information across borders. For too long, this is a position which has been supported without question in the west, and those who have challenged it have been routinely tarred and feathered by the press. This lack of an open debate about this aspect of the white god is not a good thing.
- The PRC government should clearly state its position on data, and express how far it intends to go. If the government stakes a claim to all PRC citizen’s personnel data, will they extend that to their medical information and later, genetic data, too? Will the individual have any control or recourse over their own data, or will the government always be the final arbiter and decision-maker? The Chinese government should makes its position clear, without resorting to slogans and nationalism.
This would be best for everyone, especially the Chinese people.