The China Vortex

It has been a long time since I last posted, for which I apologize. I won’t insult your intelligence by offering some excuses, but I will try to get back on a more regular schedule. I thank you for your understanding. If you would like to follow an unadulterated distilled real-time version of my thoughts, then I’d encourage you to follow me at twitter.com/pdenlinger

Today is the first year anniversary of the May 12 earthquake which killed an estimated 100,000, mostly in Sichuan, and causing untold damage and suffering. It also awakened the Chinese government and people to the suffering of ordinary Chinese in a way which did not happen before. I don’t have anything to add which I have not already said in the previous year, so I will offer a few links which I wrote last year.

@GregoryLent on Twitter just pointed me to this article, A User’s Guide to 21st Century Economics, by Umair Haque which I recommend highly.

After reading this article, some questions which came to mind:

• Chinese companies traditionally have not been good at adding value. How well can they adjust to the new 21st century economic situation?
• Chinese companies have been spending much on acquiring steady supplies of raw commodities. How much are they thinking of what is needed for the 21st century? Will they continue to build a twentieth century economy modeled on the American model, which is going defunct rapidly, or will they build a new development model for the 21st century?
• The 21st century development model is reliant on individual human talent and creativity, and making it possible for them to succeed. How is China going to attract the best minds in the world to China in the 21st century?

Gladiator movie poster

At the end of my previous post, where I painted a generally pessimistic picture of the near future, I mentioned that I would write about the businesses which would do well in this downturn.

In my opinion, they are bread and circuses.

During the decline of the Roman empire, the Roman emperors realized that in order to prevent uprisings, they needed to feed the people (bread), and to entertain them (circuses). Life was grim, ugly and short. People lived for the day. People were reduced to their most basic needs, food, sex and entertainment. Everything else was unnecessary, and most likely, did not do well as a business.

The most popular entertainment of the time in Rome were massively staged gladitorial spectacles which were fights to the death for the gladiators. When people were this miserable, they wanted to have power, if only for a moment, to see others fight to live. People were not happy, and they got pleasure and enjoyment out of what some would call sadistic entertainment (in happier times).

The Roman emperors provided a huge spectacle as an outlet for this frustration in the form of gladiator fights at the coliseum. Instead of trying to resist this angry urge, they saw that the only way out for them was to channel the urge away from them. The state rode this wave, and brought Hollywood production values and state funding to this entertainment to keep the sheeple happy. That is how they were able to extend the period of decline in the Roman Empire to 400 years instead of being overthrown much earlier.

Bread and circuses.

The times we live in will be very similar.

In China, where entertainment is already a large part of what makes up the Internet, there is already a very large entertainment component.

Historically, Chinese rulers have been experienced at putting down rebellions and uprisings, but when it came to entertainment for the masses, they could not hold a candle to the Roman emperors. On the other hand, they did not produce characters quite as twisted as Caligula and Nero either. The Roman emperors were in a league of their own.

Now, how to get state funding and production values for huge epic productions which recreate the smell, blood, excitement and drama of a real gladitorial spectacle as was captured in the movie Gladiator? Whoever can answer that question and can figure out how to bridge online games and the real world drama of life and death gladiator fights, creating a whole new experience, is in the money, not only in China, but globally.

Plus ca change, plus c’est la meme chose.

For a long time, I have been telling my friends that China is not going to use its foreign exchange reserves to bail out the US and the rest of the world. Aside from the fact that China does not feel like a superpower, it is becoming apparent with each passing day that China has very real problems of its own, and is going to have use its own reserves to help itself.

Another popular argument is that the newly rich Chinese consumers will go out and spend their yuan, helping the newly poor west out of its self-made predicament.

I have a few stories to tell you which make me doubt this.

Recently, at an apartment in Beijing, I went out to take the garbage, which is in the common area of the building near the elevators. Shortly after going into this area, I noticed that the only lights in the area, which has no windows, were two low-energy consumption bulbs on the other side of the area. Nothing else was on except for those two bulbs, including the stairwell, which was completely black and did not have any lights on. Obviously, the building management company, in an effort to save electricity, had turned off the lights to less than what I would consider safe.

So these are the same guys who are going to bail out western consumers from their problems? Hmmm….

Anyone who has stayed in China for any length of time will find small cards which have a photo of an attractive young woman smiling prettily, with a rate card and mobile phone number on the back. On these cards, the young woman will offer “massage services” with services called 西班牙骑士 and 综合保健 offered. Sometimes the cards mention that the young woman is a university student.

Now, what caught my attention recently was that their rates had gone down! The most expensive package 综合保健 or Total Healthcare Package had gone down from 398 yuan to 298 yuan. My guess is that the market was pulling back, and these young women were asking for less, at least according to my completely informal China Masseuse Index.

Then yesterday I flew from Beijing to Shenzhen. On arrival at Shenzhen airport, I took a small 20+ person bus to downtown Shenzhen. During the ride, as we were going downhill, I noticed that the bus mysteriously went silent. Then, it occurred to me that the bus driver had turned off the engine to save gasoline/petrol costs and was coasting downhill until we reached the toll booth. After we reached the toll booth, he restarted the engine, and we were on our way.

Taken in isolation, I would have said that each would at most, have been an interesting and amusing anomaly. Taken together, they paint a picture of a society which is indeed worried about the future, and is doing its best to cut expenses.

So that, from the street, is my reasoning for thinking why China will not help the west. It has too many problems of its own.

UPDATE: Caijing, the leading economics and business magazine in China, has a short report which supports my observations about falling energy demand from Chinese consumers. (h/t to Bill Bishop)

With all the chaos on world’s markets, it is easy to overlook developments in China. The biggest piece of Chinese domestic news is the decision to give limited rights to land use to China’s farmers. This decision came out of the Third Plenary Session of the 17th Party Congress of the Chinese Communist Party (三中全会), which is now convening in Beijing.

The overall thrust of this meeting is to focus on the development of rural China, which has not fared so well as the east coast cities. If the cities continue to develop, and the countryside continues to stay poor, you have the recipe for social unrest on a large scale.

The salient points about China’s development are that China has about 1/3 the arable land of the developed economies for farming, and about 500M live in cities, while 800M continue to be rural Chinese. National development plans (many of which were formulated under Jiang Zemin, who came from Shanghai) called for the urbanization of China.

China’s first 30 years of reforms required the development of the eastern coast to attract foreign capital, and to make the companies and the westerners who came to China feel comfortable. Only when they had reached some level of comfort, and were attracted by the market potential would the capital follow. They became comfortable and the capital and trade followed.

And now the westerners living in Beijing, Shanghai and the west expect the Chinese with their nearly US2T in foreign reserves to bail out the western economies? Let me tell you why it won’t happen.

• Successive Chinese regimes have always lost power when they coddled the urban elite and ignored the needs of the countryside. This was how Mao rallied the Communists, surrounded the cities (the strategy was called “using the villages to surround the cities” or “乡村包围城市”), then threw out Chiang Kai-shek in 1949. Hu Jintao and Wen Jiabao know this, and know that they need to swivel around and develop the countryside so that the wealth gap can be narrowed.
• The Chinese government will focus on developing a new size of town, which in Chinese is called the 城镇 or village town. This will be mainly a distribution, education and trading center for farmers and their families in the immediate vicinity. Population will be 250-500K.
• For the next 15-30 years, the cities will stagnate in growth. People will not lose their homes the way they do in the US since China does not have foreclosure laws, but their salaries will not go up. Many of the wishes new university grads entering the workforce hoped they had will just become dreams. Somehow they will have to learn to live in this new drastically changed environment.
• The Chinese government is already talking about the development of rural infrastructure including rural insurance, microlending, etc.
• Many young Chinese who would have scoffed at the idea of working in the countryside will now go there, simply because job opportunities in the east coast cities will be limited. This, in turn, will help to clean out the party apparatus in the countryside, which has been seen as generally corrupt.
• Western companies will not benefit too much from this next stage of development because they do not, for the most part, understand how to sell to the bottom 2/3 of the Chinese pyramid. Most only know how to sell to the top 1/3 in the cities. Companies which will prosper are those who sell to the “local local economy”, or bottom 2/3, as Jack Perkowski calls it, as opposed to the “local foreign economy”. The local foreign economy is city-based on China’s east coast; the local local economy is mainly rural and inland.
• The companies which will survive and prosper are the swift pivoters who can quickly learn how to sell to the “local local economy”. This means that they made some money in export manufacturing, but now switch to sell domestically to Chinese consumers in the new inland towns and cities. Not many companies can do this, but those that do will do well. Most will be entirely new businesses, and local Chinese brands will have an advantage.
• This next stage of development will require a lot of money. Those foreign exchange reserves of US2T will be needed by China. Now, if you ruled China and you had the choice of 1) lending the money to the west, which has just acted about as irresponsibly as anyone can imagine or 2) investing the money in China to narrow the wealth gap between rich and poor, city and countryside and keeping your regime in power for more than a half century, what would you do? I think that it’s a pretty easy choice.

China may now have the world’s largest foreign exchange reserves, but that is not what makes a country a superpower. The recent tainted milk scandal has shown that it is still lacking controls in many key areas, and it is far short of being a developed nation. Instead, China is a developing nation with rich reserves it needs for its own development.

In order to become a developed nation with a developed economy, it needs to spend that money on building its own infrastructure and narrowing the wealth gap between the developed cities on China’s east coast and the inland countryside. Any Chinese regime which acts otherwise would be making a very risky decision, and would be putting the future of its own rule in jeopardy.

China can manage without export markets, but it cannot survive if its own countryside is in turmoil.

There has been a lot of concern about the tainted milk scandal in China, and with each passing day, the scope of the scandal gets bigger. How did this happen, why was it covered up, and what needs to be done about it?

My answer is simple: this is the kind of thing which happens when the bureaucracy becomes politicized, and government appointments are made for political instead of professional reasons.

For more than 2,000 years, when China was ruled by an imperial bureaucracy, China had a complex system of imperial exams to insure that anyone who passed could enter the government bureaucracy. This bureaucracy was largely apolitical, except for the most senior appointments in the imperial court or on the provincial level. Most were just professional officials, and would serve their masters, whoever they were.

With the overthrow of the Qing dynasty, and with the foundation of new China in 1949, the party organization affected all levels of the bureaucracy. Endless political movements until 1978 politicized the whole society, not just the bureaucracy. Appointments were made for political reasons instead of professional capabilities. Sometimes, professional qualifications were completely ignored.

The tainted milk scandal is an example of what happens when political considerations override business, health and even ethical concerns. This is what happens when government officials are judged by how much investment they attract and how many jobs they create. Then there is a natural tendency to cover up any information which draws a conflicting picture. What should be a health and ethical issue instead becomes a political issue.

The problem now in China is that there is a severe shortage of people who are apolitical professionals, not politicians. How do they fit in, even survive, in a completely politicized bureaucracy? Does the government have the energy and will to depoliticize the bureaucracy, and create a professional bureaucracy which will fulfill the needs of modern Chinese society?

That is the question for the next stage of Chinese reforms.

Just in case you had any doubts that the world was going to hell in a handbasket, and that the inmates were running the asylum, you just might have had some of those doubts removed in the past week. And those doubts were removed in a very dramatic fashion, as in frontal lobotomy fashion.

“George Carlin, why did you have to die so soon, just before all the fireworks started? Did you actually think that the world was becoming so ludicrous that you couldn’t take it anymore, or think that you would run out of material?”

Let’s look at some of the fun things which happened this week:

• Sanlu’s dairy products were found to have killed three babies, and caused injury to several thousand others (at least)
• Baidu was accused of offering to help cover up the scandal by not showing the scope of the scandal in its search results. I wonder what genius came up with the idea that they could cover up a scandal of such immense proportions for a miserable 3M yuan? And who was the genius on the management side who approved such a deal? This would have taken at least two people who had frontal lobotomies. Most of the time, people who come up with dumb ideas like this are only employed in government (Most notably the US government, where they usually run smear campaigns for politicians during elections.) As for Baidu/Alibaba, now Baidu is threatening to sue Alibaba for spreading the Sanlu story. (Isn’t China becoming more like the US every day? At this rate China will be run by lawyers in five years. A sure sign of national dementia.) Are these initial signs that the Americans’ efforts to package and sell stupidity to the Chinese are showing signs of success?
• Lehman Bros., a US investment bank, declared bankruptcy, and Merrill Lynch sold itself to Bank of America for $50B. I have the utmost admiration for John Thain: Imagine taking a company which was rapidly going down the tubes, whose assets were unclear, and whose non-performing CDOs were increasing by the hour, and he SOLD it for $50B, finding a buyer in BA? Wow, that’s neat! How’d he do that? These bankers are amazing. None of that piddly million here, million there kindergarten dotcom stuff for these guys, we’re talking real money here (even though it’s US dollars).
• Is it just me, or am I thinking that Imagethief’s time has come in China? I keep on fantasizing what his first lessons for new official clients might be like. How about this:
  

  “First of all, let’s get it clear that lies, coverups and people getting poisoned are a necessary part of any nation’s path to greatness. There is no need to deny or cover it up; we must celebrate each event as achieving yet another milestone to greatness! Let’s celebrate it! Let’s roll in it! And let’s become more and more like America with each passing moment! Look at how the Americans don’t discriminate against the mentally handicapped anymore; instead they make them their leaders! If America can do that, then why can’t China! Our goal must be to pollute the global financial system on an even greater scale than the Americans have: this will show the world China’s power!”

Hmmm, on second thought…
UPDATE: Once upon a time, jokes were about comical situations which had a tenuous relationship with reality. Now, the jokes ARE reality.
DISCLAIMERThe above story is pure satire. Don’t take it as anything else.

One of the fun things about China, and the Chinese Internet, is that new issues can pop up very quickly, and become major issues.

This has just happened with the issue of user privacy on the Internet. With more social network sites, and more users posting real information about themselves, along with contact information, etc. this has become a real issue.

I’m not going to offer a solution to this very complex issue. Instead, I’d like to bring up another issue: “How do you have a productive discussion, where all get a chance to contribute to the debate, get heard, and then come to some kind of agreement about a solution?”

Here is the problem. This issue flared up when many SNS sites started blocking Baidu’s spiders from crawling their sites. The official reason: to protect users’ privacy.

The problem is that there has been no discussion about what user privacy is. The definition of privacy is very different for a 12 year-old girl and her 40 year-old mother and, in turn, is very different for a 22 year-old gay man.

Each of them, or their parent/s, may have very different ideas of what constitutes user privacy. The gay man may not want to reveal his sexual orientation except for his closest male partner/s, and may not want anyone else, including family, to know. The same goes for religious affiliation, etc.

These are very real issues which need to be discussed and thrashed out in the open, and people need to be able to put forth their views for discussion. This is a vital and natural part of what constitutes a civil society, which is what the Chinese government supports and advocates.

Unfortunately, there is no clear mechanism for discussing a very complex issue like user privacy in China today.

Instead, we have companies coming out with thinly-disguised excuses about privacy, when in reality it looks more like a pissing match between companies over whose spiders can crawl over whose sites. Are the two groups going to come up with different, even opposing, ideas and definitions about what constitutes user privacy, and force people to choose one or the other? If that is the case, then it’s not really about user privacy, it’s about choosing between one camp or the other, with every user forced to make a choice.

But that isn’t what the Internet is all about. The Internet is all about empowering people so that they can make their own choices. The Internet is about pushing decisions to the edge, where people make their choices, and if they don’t like them, they can change them later on.

This is what is missing in China. Without this system or mechanism, there is just endless bickering and noise, and what should be a serious discussion with a well-thought conclusion, usually ends up in a lot of noise with the loudest shouters winning.

What is an important issue, usually ends inconclusively.

Or as the Chinese say 不了了之。

Chinese Internet users deserve something better.

Then I should be truly indebted to the 37thinker website which has copied my articles in full (right down to my internal backlinks) here and here.

Now please stop copying my articles without my permission and come up with your own content!

You’re not doing China’s reputation any good.

Alibaba has announced plans to consolidate two of its subsidiaries into one company. Alimama is the company’s ad network for Chinese SMBs, and Taobao is the company’s auction platform, which is best known for dramatically driving eBay China out of the China market after eBay bought Eachnet.

This is likely a measure to counter Baidu’s plans to enter the e-commerce market. According to this report from Keso, Taobao has blocked Baidu’s spiders from crawling Alibaba. Spiders from other search engines are not blocked. It is very unusual to hear of one search engine’s spiders being singled out for blocking; I have never heard of this until now.

Can you say hardball?

Spiders are software programs used by search engines to crawl other websites; they detect changes in websites and report changes back to the mothership search engine which are used to update the search engine’s search index.

According to Keso’s report, Jack Ma of Alibaba believes that Alibaba’s SMB e-commerce platform represent the family jewels, and he already has enough users to allow him to make such a dramatic parting of way’s with Baidu. Baidu is currently China’s largest search engine player, with more than 60% market share.

For Baidu, losing the capability to crawl Alibaba’s sites represents a huge loss, and puts more pressure on their nascent e-commerce platform to succeed. Otherwise Baidu’s e-commerce search results will look very weak, just as e-commerce is showing signs of takeoff.

Now, Google China is the wild card which might benefit from the Alibaba/Baidu faceoff. Significantly, Google China’s spiders are not blocked from crawling Alibaba’s sites. Jack Ma has three options:

• Build his own search engine team which would build its own search engine to crawl Alibaba sites;
• Make Google.cn the default search engine for Alibaba and its subsidiary companys;
• Go to Google China and propose a joint venture company which would have a separate search engine to crawl Alibaba sites. Search advertising revenue would be split between the two companies.

From a technology perspective, search engines are more challenging to build. Specifically, they need to continuously update their search index, although if the search engine is only pointed at the Alibaba community, it would not be as difficult. Search engines need to be continuously updated and modified to get accurate search results, although optimization on organic and paid search are very different in how they are updated and modified.

From the SMB users’ perspective, the key to success is providing a smooth and transparent transition between search advertising and online business transactions. Bad user experience has led to the downfall of many a business, most recently eBay in the US, which has continuously raised fees on its auction platform, driving away its originally fanatical loyal user base, and forcing it into a retail model which competes on unfavorable terms with Amazon, the online retail ecommerce leader in the US.

Things are getting interesting…