Commentary: Chongqing as Chicago on the Yangtze

August 18th, 2010

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.

The New Investment Rules For China

October 5th, 2008

Following on the global credit crisis, many have come to me to ask how these changes will affect China. As I have said earlier, China and the US are two sides to the same coin, and it pays to look at them as one economy, as this Newsweek article does. It goes without saying that this crisis will have a profound effect on China, and I’m not optimistic about the capability of the Chinese central government in Beijing to deal with it as quickly as it should. Michael Pettis, who lives and teaches in Beijing, has been a persistent advocate of stimulating more domestic spending from Chinese consumers, and continues to advocate that position. I agree that this is necessary; I don’t think that this will happen quickly or on an even basis. There is a simple reason for this: stimulating consumer spending depends, to a large extent, on the rollout of a national healthcare system; this is something which Beijing has tried to do since the early 90s, all without success. When it comes to the lack of a national healthcare system, the US and China are in the same boat, and the national governments are equally ineffective.

So what are some investment rules you can use? Let me list seven below:

  • Avoid Shanghai and Beijing. Both have excellent universities, and Beijing has central government ministries while Shanghai is the commercial capital of China. In IT, companies have preferred to hire from Tsinghua for smart technology people. But there are major problems with both cities. First of all, staff turnover is too high, and costs are too high. In the past few years, staff have routinely asked for 20-30% raises just to stay in the same company! And with all the western companies constantly going into those cities, there has been a bidding war for staff. We are in tough times now, so do you really want to get involved in bidding wars over your local staff and deal with staff turnover issues? I don’t think so. And when it comes to Internet/IT, I say that the Internet already has become a platform and there is plenty of talent around. Do you really need expensive people from the very best universities in China who may prove a pain to manage? If you don’t, second-tier people who are reliable and don’t ask for huge pay raises are good enough, and maybe even better. When hiring local talent, look for tortoises, not hares. We are heading for much tougher times, and you need a good stable team. Beijing and Shanghai have too many hares. Your most loyal people will be the ones you hired and trained on the job. They will also be the ones who understand local market and conditions and connections.Another major issue about Beijing and Shanghai is that they are geared for exports, especially to the US. Do I need to tell you what happened to that export market?
  • Instead of going to Beijing and Shanghai, look at the 20 major city markets in China if you are thinking of selling to Chinese consumers. Now is a good time to get into services for Chinese consumers. Think of cities like Dalian, Hangzhou, Ningbo, Xiamen, Guangzhou, Wuhan, Nanchang, Chongqing, Chengdu, Fuzhou, Kunming, Nanning, Nanjing, etc. If you want to get into China under the radar (in my opinion, always a wise strategy), these are places to look at very seriously. If you need knowledge workers, as in programming or game production or pharmaceuticals, pay special attention to the local universities, and partnering with them to hire their graduating students. If you show the cash and commitment, and can guarantee jobs for their students, you will get multiple offers of good deals.
  • Guangdong and Zhejiang are the two largest manufacturing provinces in China. Guangdong’s factories depend on a huge pool of unskilled immigrant laborers, mostly young women, from Sichuan and other provinces. These factories and workers are going to be hit hard because of their dependency on the US market. There is too much overcapacity, too little value-added, and too little profit for most of these factories to move up the value chain. Unemployment in Guangdong and Sichuan will become a major issue. Zhejiang’s factories are mostly family-owned, and it has less reliance on immigrant workers. Because of Zhejiang’s strong private sector and private wealth, they will be able to make the adjustment in market demand from exports to domestic Chinese consumption more quickly.
  • If you are a private equity or hedge fund investor, you need to think about investment horizons. In order to make up for the dropoff in exports, Beijing and provincial governments would naturally think of investing more in infrastructure. So far, most of this money has gone into infrastructure, manufacturing and real estate. The problem is that these areas are already built up and have over-capacity. They are really at a loss about what to do. If you can help and offer investments which create jobs and upgrade the skill force, you are in a good position. Be sure to get your money and profit back within 15 years (by 2023). That is because if you are selling to Chinese consumers, you are selling to the current group who are in their 20s – 40s. By 2023, China’s demographics will fall off a cliff because of the one-child policy, and they will be in savings mode instead of spending mode.
  • When it comes to modernization, China is crossing a 30-foot chasm with a 20-foot rope, with each foot representing one year. China’s hardware development and infrastructure are very impressive and are the most modern in the world, as the Beijing Olympics showed. The hardest part to modernize is peoples’ mentality as the tainted milk scandal has shown. China’s aging demographics do not give it enough time to cross the chasm, so Chinese will get old before they get modern. When that happens, China will look like a bigger version of Japan, and will have all the problems Japan has today. Just hope that China has a national healthcare system in place by then.
  • The wealth gap will become wider over the next 10 years between the cities and the countryside, then stabilize for five years, then shrink as the city worker bees retire in 15 years. Rural infrastructure is less developed, and so far, the Chinese government has made all the wrong moves in rural development by not supporting the development of rural collectives for the farmers. There is an excellent article (in Chinese, h/t to Stan C) about the failure of China’s rural development, and how Chinese rural development will look like the Philippines with large food processing companies employing poor farmers. This organization is partly responsible for the Sanlu tainted milk scandal, and is copied from the US. But the US has a surplus of land and shortage of farmers, while China has a shortage of land and excess of farmers! If you are interested in macroeconomic issues, this is worth more study. Its view converges very well with the view of Yasheng Huang in his new book Capitalism with Chinese Characteristics, which I have also mentioned in my previous article.
  • The dumb money has already been made in China. It’s time to rebalance your portfolio to make smart money. It can be done, but it won’t be easy. Think smart, work smart, and invest for 15 years. By that time, you should be able to retire.

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Is Faster American Decline A Good Thing…For America?

September 10th, 2007

Rebecca McKinnon has a very interesting post at her blog “Thomas Friedman gets the middle finger in the Middle Kingdom”, which was part of her coverage of the World Economic Forum at Dalian.

During a panel, Thomas Friedman, author of The World is Flat, accused China of being a “free-loader” while the US carried the heavy load of being a “global guardian”. I really love the term “global guardian”; what does it mean? Does it mean that the US is protecting the globe
from an attack by Mars? Or Jupiter? Or is it some unknown Deathstar which we don’t know about? Does it mean that Beijing is keeping this a secret from the rest of the world so that it won’t have to publicly acknowledge this enormous debt to Washington DC?

Who defines the role of “global guardian” and the role it involves? It takes a lot of hubris even to bring the phrase up. How would you react if your spouse calmly announced that he was the “global guardian of our world against evildoers who want to destroy our way of life”? I think you get the drift…

Then in the post,

Friedman also argued that it’s in China’s interest to work more directly with the U.S. on geopolitical issues because if the U.S. fails, then China will have to pick up the pieces. “If there is too little American power China will be forced to respond to that,” he said.

Now I get it, Beijing is supposed to change Washington DC’s diapers when it makes a mess! So now Beijing is going to be the “global diaper changer” when the “global guardian” has… well, nevermind.

Unfortunately for Friedman, Sha Zukang, told the audience that the Chinese government is not anxious to assume this new role.

Sha rejected the whole idea of “soft power,” calling it a “condescending approach” and “notion created by Western developed countries.” When it comes to world leadership, he said the world’s leaders should not be “self-proclaimed” – he said they should be elected. China, he said, would not self-proclaim itself a world leader, because China’s policy is always to treat other countries as “equals.”

Translation: “Let’s take responsibility for changing our own diapers, instead of expecting someone else to do it for us.”

Another very interesting viewpoint put forward by Clay Chandler of Fortune magazine is that now that China is a world power (I really love the way the words “world” and “global” are thrown around), Chinese politicians are still giving boring speeches. Of course, American politicians never give boring speeches; I’m sure that any intelligent reader of this article can recite all the speeches of George W. Bush and the Senate and House heads by heart. Yes, I too, am deeply disheartened that Beijing has not announced plans to stage a pre-emptive attack against Mars so that the “global guardian” can at least take a small rest and enjoy a cup at Starbucks.

Seriously though, Friedman’s criticism of Chinese policy is, at its very least, an acknowledgement that the US has not been able to carry all its burden by itself and needs help. In this light, it should be interpreted more as a plea for help and assistance for the global guardian than as a rebuke of current Chinese policy.

In the article, Rebecca recalls:

A couple years ago a Chinese academic who advises the Chinese government on foreign policy issues told me that the best way for China to build global power, good will, and international credibility over the long run is to mind its own business, avoid criticizing the U.S. whenever possible, sit back and let the U.S. destroy its own power and credibility by itself.

There is a strong argument to be made that it isn’t so much that China has risen quickly out of seemingly nowhere, but that China’s growth appears accelerated because of rapid American decline. Put it this way, if China is riding an up escalator, and the US is riding a down escalator, at some point they will pass each other at an intersection point.

The only question is “When?”

Now the question becomes whether it is a good thing to accelerate decline. Wall Street routinely rewards companies which make dramatic management changes when they are in decline. The thinking is that it is better to make dramatic, even wild, changes in the face of falling sales and market share. Share prices go up even before the results of those changes become apparent, based on the hope that the new management can make the changes necessary. Wall Street is hoping for a happy ending, even though most of the time it doesn’t work. Doing something, even if it is madly wrong, is better than doing nothing when confronted with a bad situation, according to Wall Street. Then, when the company has hit bottom, it can either be acquired or claw its way back to recovery.

My question is whether this same rule should be applied to countries and governments? If the US is in a state of systemic decline, is it better to accelerate the decline, so that the country can eventually climb out of the mess it is in? The problem with this approach is that when a company screws up, a few hundred thousand people lose their jobs.

The problem with a country, especially one as big and powerful as the US, is that no one knows what the bottom looks like.

For this reason, the slow erosion and decline of American power will continue.