China’s Misreading Of The Global Economy

August 31st, 2010

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.

Excuse Me! How To Regulate Micropayments?

August 27th, 2008

In China, you know something has become big when the government starts worrying about how to regulate it. (Come to think of it, that’s the way it is with most governments, not just China’s.)

China’s central bank, the People’s Bank of China, has asked the Finance Department of People’s University in Beijing to come up with draft plans to regulate micropayments in China. (People’s University is traditionally the training ground for government officials.) Right now, micropayments occupy a gray area, which means that they are not technically legal or illegal. They just exist.

And they are unregulated. Right now, the Chinese government has no idea about how to regulate this market, which it obviously expects to grow substantially. Some have even grumbled that this new virtual economy will eventually grow in size to rival offline economies.

The most successful subscription micropayment based company in China is Tencent, which is based in Shenzhen and gets unofficial support from the Guangdong provincial government. (The Chinese have a saying: 天高皇帝远 which literally means “The skies are higher when the emperor is farther away.” Unfortunately for most western companies, they are not aware of and do not heed this very wise Chinese saying.) It has its own virtual currency, the QQ-Coin, which can be purchased one-way with Chinese yuan, but cannot be converted back into Chinese yuan. The company recently announced record earnings.

You get big, you get regulated.

Chinese Government’s CSRC To Fund Managers: No Bad News

July 29th, 2008

The Chinese government’s watchdog for equities, the CSRC (China Securities Regulatory Commission) has issued an edict to local fund managers that they are not to issue any pessimistic reports about equities during the Olympics in Beijing.

My question is “Why bother?”

The Shanghai market has been down 50% in the first half of the year, and what started out as a subprime mortgage problem in the US has now morphed into a banking problem with more US banks at risk.

In the meantime, Pony Ma, CEO of Tencent has joined in the chorus with Alibaba’s Jack Ma to talk about hard times ahead. The Chinese government has signaled that the rise of the yuan against the dollar will slow down, with a very public discussion in the People’s Daily. The signs of economic deceleration are everywhere.

When there is so much public discussion about upcoming economic challenges in the Chinese and western media, what good could possibly come from telling local fund managers not to say anything bad which might upset the Chinese equities markets? While many western observers of China see this as a sign of an authoritarian regime, for many Chinese, it looks more like desperation. Instead of allaying fears, it makes those who are still in the market fear the worst, and think that the government is trying to suppress even worse news, which in turn will fuel the rumor mill and make the market even more volatile.

In short, this looks more like a desperation move than a well-thought policy move. Instead of helping the market, it’s likely to make things worse.

This is what happens when politics interfere in the markets.

Personal Lending + Web 2.0 + China = ?

March 2nd, 2008

qifang_logo.jpg

Two new startups in China have now entered the field of Internet-based personal lending and finance in China, and according to this article in China Web 2.0 Review, one of them, PPDai has already received first-round funding for an undisclosed amount from Essentia Equity.

The concept of personal lending is an outgrowth of microfinancing, which started with the Grameen Bank, founded by Muhammad Yunus in Bangladesh in 1971. The idea was to lend money to poor villagers, mostly women, in very small amounts. Banks did not lend money to these people because they did not have any collateral. Instead, these often illiterate women were asked to become co-signers for their fellow villagers’ loans, effectively guaranteeing the loan in case the borrower defaulted.

In the developing world, microfinancing has become an overwhelming success, and in recognition of his contribution, Muhammad Yunus was awarded the Nobel Peace Prize in 2006.

In China, the concept of microfinancing has been slow to gain traction in spite of official Chinese government support. The Chinese government still has four large state-owned banks, and it is much more profitable for them to pursue mortgage lending in China’s cities than to embark on lending to villagers in the Chinese countryside.

Now, add to this the Internet and Web 2.0. An important component of the promise of Web 2.0 is the idea of building new communities where people can feel a sense of community without feeling separated by time and distance. The most important online communities which have sprung up are MySpace, Facebook and LinkedIn. Among these three, LinkedIn, which is targeted at the business community, is now reputedly cash-positive, and will shortly announce IPO plans. Facebook had only US$150 million in revenue in 2007. While Facebook and MySpace have far greater membership numbers than LinkedIn, ad revenue has been disappointing, if only because it is hard to create effective creatives and clickthroughs for such a geographically diverse group with such wide interests.

In personal lending in China, the two web-based personal finance sites are PPDai and Qifang. Both companies propose to bring Web 2.0 tools to personal lending, making it easy for strangers to lend money to each other, and also including some kind of an informal feedback mechanism which would take the place of a finance credit system which has not yet been fully launched in China. Underneath it all lies the belief that the Chinese are now ready to experiment with and use a new web-based front-end system for personal lending. (On the backend, these systems tie into traditional bank payment gateways.)

Critics would say that the success of microlending depends on two factors:

  • Trust in developing societies depends on face-to-face contact between the lender and borrower, and ideally, they should live in the same community
  • China is now a low-trust society where people will run off with any money they can get their hands on

On the other hand, the Chinese government has put its very powerful media apparatus behind the idea of creating a “civil society”, which is a fancy way of saying that they would like Chinese to trust each other more, since the shysters are giving the society a bad name. Now, what could be more trusting than lending someone you have never met, or been referred to by a personal friend, money?

Qifang, in particular, has a strong social angle since it is targeted mainly at serving China’s students who are looking for funds to pay for their education. It has recently received coverage in TechCrunch in the US. In China, university education is an important indicator of future income, and poor families are willing to go into debt to send their single child (or children in the countryside) to good schools.

It will be very interesting to see how well these new and very innovative companies are received by Chinese users, and it would probably be fair to say that they will be very interesting barometric indicators of how much change and evolution Chinese attitudes to money and lending are now undergoing.