Has China Embraced An Outdated Version of Corporate Capitalism?

August 23rd, 2010

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.

China: Which Century Are You Building For?

February 21st, 2009

@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?

China: Last Man Standing?

February 17th, 2009

On this blog, I have been a frequent critic of the view that China is a threat to the rest of the world as a rising superpower. Most of the time, these critics have a clear agenda to sell with regard to fear of China, or are journalists who have very little understanding of China. If the latter group, their articles are really rehashes of “If China were a rising superpower like US/Britain etc. this is what China would be plotting to do.” For someone who has never been to China and does not understand the country and people, the argument makes sense. But for someone who has been in China for some time, it’s ridiculous.

The reason for this is very simple. Running a country of 1.3 billion people is a very tough job, and this is something these China newby articles invariably overlook. In simple terms, the daily challenges are huge and are much bigger than the rulers of the US and UK have to deal with. For the most part, Chinese are not nearly as docile as Americans and Britons, and are much more “creative” about the ways they express their unhappiness. The knife hiding behind the smile or 笑裏藏刀 is a useful phrase to be aware of in business and politics in China.

In recent days a new theme has popped up, and that is the government incentives from the Chinese government are beginning to show positive results in the Chinese economy. Some of the articles are:

The Chinese government has acted forcefully, much more so than western governments, in fighting the effects of this recession which has turned into a depression. Compared to the west, the Chinese government has been the model of efficiency.

Sources in Beijing have told me that the Chinese government has offered companies full salary subsidies for company positions. That is, they have offered to reimburse companies full salary for positions in companies, especially positions for new university graduates. I am not sure if this applies to SOEs or if it also extends to the private sector. I am not aware of the full details of how it is implemented, but it does have the ring of truth. This has created a favorable market for employers, as many companies routinely lay off 80-90% of students following the three-month probation period.

Coming back to the rising superpower theme, this serves as an excellent illustration of a major point of mine: to become a superpower, you really don’t need to have a plan for world domination. You only need to be the last man standing when everyone else has already collapsed.

It will be very interesting to find out how long China will stand? The Chinese government is running the distinct risk of using all its bullets too early, and not having any left if the depression continues over a prolonged period. If that happens, the only thing China can do is inflate its way out. Another article point out the risk of this approach:

If the depression is long and this scenario plays out, then China will become a very short-lived superpower, and will only be standing a very short time before it collapses on top of the heap with the other former superpowers.

You only win when you can walk away after the battle. Otherwise it is just a pyhrric victory.

(Trouble is, pyhrric victory is a western term which does not an equivalent in Chinese.)

UPDATE Feb. 20, 2009: Knowledge@Wharton has an article about the possible ramifications of the surge in lending by Chinese banks.

Chinese Economy: Early Signs of Rapid Deceleration

July 23rd, 2008

Some signs point to a rapid deceleration of the Chinese economy:

The whole idea of an urgent politburo meeting just three weeks before the Beijing Olympics is a strong indicator of how serious the ruling levels of the Chinese government see this situation and would, in my opinion, be an ominous sign.

All of the signs point to an economy which is rapidly deflating, following on the falling performance of the Shanghai stock exchange, which has fallen more than 50% in the first half of the year. A lot of money which people thought they had made, and did not think of converting into cash thinking that it would go higher, is no longer there.

In China, this is always a warning sign of potential social instability. It also explains a lot about why the Chinese government has introduced new licensing regulations for online video and other communications means where people can communicate quickly, spreading views contrary to the official line, and events can quickly spin out of control.

If the Chinese economy deteriorates, as signs suggest, then it would be safe to say the government controls would tighten further. This would especially be the case in areas where foreign investment capital has gone into sensitive media sectors, which is always viewed with some degree of suspicion by the Chinese government.

China’s Biggest Challenge for Developing the West

March 30th, 2008

shanghai.jpeg

The Chinese government has done much to encourage the development of China’s west, particularly Sichuan province, which is the home to some 100 million people, making it larger in population than any single western European country, including Britain, France and even Germany.

From a business and consumers’ point of view, the region holds tremendous promise. Many large western companies, including Intel, Wal-Mart, MacDonald’s and KFC have all moved into the region in the hope of capturing some of the yuan which locals have to spend. From a consumer marketing point of view, and also from the manufacturing point of view, the region holds great promise.

However, this is still not enough. Compared to the east coast region’s of China, it is still far behind.

So what is holding the region behind in development?

In two words, it’s human talent. “Interesting places attract interesting people” is one of my favorite mantras. When I go to a place, I like to find interesting people, regardless of their profession, and listen to what they have to say. I look for different angles and insights from individuals which I cannot easily find elsewhere. Most of the time, I think of these people as very smart generalists.

My experience is that Shanghai and Beijing is full of interesting intelligent and very talented people, which is why I’m attracted to these two cities in China. They are evolving rapidly, which means that these cities have not yet congealed around certain professions in the way American or European cities, or even Hong Kong, have. They are full of surprises, and most of the time, these are pleasant surprises.

My theory is that these two cities draw the best Chinese talent away from the rest of China, leaving the other cities to struggle with the people they can convince to stay there, who usually are not as smart and talented. So, when Chinese or expats talk about Tier 1 cities (Beijing and Shanghai), they could just as easily be talking about quality human talent.

This creates a problem for western China: they have the consumers, and they can have good manufacturing up to the middle of the value-added chain, but they cannot catch up with Beijing and Shanghai at the top of the value chain.

Unless cities like Chongqing can figure out a way to keep the best human talent in Chongqing, the wealth and knowledge gap between the western part of China and the Tier 1 cities will continue to widen. Instead of climbing to the top, they will peak out around the middle and won’t make it into the ranks of world-class cities.

What the Chinese government, and most other governments, fail to understand is that it is not buildings, boulevards and museums which make cities world-class, it is very literally human talent. In spite of China’s huge population, I have only seen two cities, Beijing and Shanghai, which have the potential to make them world-class.

While some Chinese may take this as a slight, it’s worth remembering that the US, which has only 1/4 the population of China, but has a longer history as an economic superpower, has only three cities which can be classified as “Tier One”: New York, Los Angeles and Chicago.

There must be some undiscovered rule which makes this the case.

Not Changing Fast Enough (Part I)

March 15th, 2008

tankers.jpg

This week’s Economist has a lead article and section on “The New Colonialists” which covers China’s expansion and search for natural resources on a global scale.

For many Chinese, being equated with colonialism is a bad thing, because Chinese have historically seen themselves as victims of colonialism, having had Hong Kong taken away by the British, and the Unequal Treaties with the leading European powers in the 19th century. When the Chinese see themselves portrayed as new colonialists, they go into hedgehog mode, curling up and sometimes fighting back against their western critics who are criticized for not understanding or being sympathetic to the Chinese point of view.

This kind of attitude is not helpful for the western critics, and is not helpful for the Chinese. The issues are real, and they are too serious to be trivialized, and for people to get into nationalistic shouting matches. The effects are huge, as they will affect the overall health of the planet.

Over the past thirty years, China has adopted an open economic development policy to raise the standard of living of the Chinese people. This policy has been enormously successful, unleashing the traditional Chinese ethics of curiosity about technology, thriftiness and hard work to elevate their standard of living dramatically. Today, China has the second largest economy in the world, trailing only the US, which is now currently undergoing a dramatic readjustment following the growing subprime mortgage debacle.

The party has been forcefully pushing a policy of development, and more significantly, urbanization of China, and plans to move more and more Chinese into cities. Throughout its long history, China has traditionally been a country mostly made up of farmers, engineers and small business people. The plan is for many of the farmers to become cityslickers, eating at restaurants, taking subways, and working in office towers.

The trouble with having so many big cities is that they are huge consumers of energy, which is why China now has to go overseas to satisfy this huge demand. Securing energy resources also means getting entangled in the affairs of many countries which are frankly, not very well-run. This in turn means that the country’s foreign policy has to feed its energy needs.

This is how America’s foreign policy and domestic energy policy got so screwed up. In Washington DC and across the nation, there is a strong and influential pro-Israel lobby, while the country depends on many middle-eastern countries which are hostile to Israel for its energy needs. These contradictions are unresolvable, and have resulted in the rise of middle-eastern terrorism and eventually in the 9/11 attacks.

Seeing these problems, it would seem to make sense that the Chinese leadership would find a new model for China’s economic development which did not depend so much on an outdated 19th century European mercantilist model for economic development in the 21st century.

Another Way To Develop Global Chinese Brands: Buy Google, Apple

October 20th, 2007

Over the past few years, one subject has dominated Chinese thinking on the government and enterprise levels: how to take Chinese brands global. During the runup to the Beijing Olympics in 2008, and then the Shanghai Expo in 2010, this subject will become even more popular, as China’s economic power grows and the US’s economic dominance gradually recedes.

So far, the thinking is that Chinese companies, with some degree of Chinese government assistance, should buy leading US brands and manage them. This was the thinking, for example, behind Lenovo’s purchase of IBM’s money-losing PC division and the Thinkpad brand in 2004. It was also the thinking behind the aborted CNOOC purchase of Unocal, an offer which had to be withdrawn because of heavy US congressional pressure over security.

Outright purchases of foreign companies, in the form of hostile takeovers and mergers rarely go well, even when the cultures of the two companies are close. When they are as far apart as Chinese and western companies, the odds are overwhelmingly stacked against success.

Now there is renewed interest in buying western companies for yet another reason: the Chinese government is sitting on US$1.3 trillion in foreign exchange reserves, and with the dollar falling against the euro and other major currencies, there is strong pressure to invest this money in something else besides US dollars, which will continue to depreciate. In order to slow down this depreciation, the Chinese government has announced that it will establish a Chinese sovereign wealth fund to invest about US$200-300B in higher-yield investments. Within the past year, sovereign wealth funds have proliferated as foreign governments seek to diversify their foreign-exchange reserves out of US dollars, especially as the US subprime mortgage lending crisis has spread overseas.

For the Chinese government, which likes to do great projects which it can then use in PR to the Chinese people, there is a fundamental bottleneck: there are not enough Chinese who have international experience managing global companies. And those who do have the skills usually decide to spend their time and effort in the private sector where their skills are more needed. In one article some time ago, Business Week claimed that China needed about 75,000 international executives while there are only 5,000 available.

There is another problem with creating global brands: in most sectors, it takes an awful long time to create them. If you look at Toyota in the automobile sector, it has taken the company mostly since the period from 1945 to become established as a leading quality maker. When it comes to manufacturing, global brands are not made, they are earned on the basis of quality products.

The place where brands have sprouted relatively quickly are in the computing and hi-tech sectors. Apple has been around since the 70s and has undergone a dramatic rebirth under the tutelage of its founder, Steve Jobs, who returned in 1997 after Apple’s acquisition of NeXT. Since his return, he has launched the iMac, iPod and now iPhone lines, all of which have won critical acclaim from users worldwide. Steve Jobs has shown that he is that rare type of executive, someone who learns from his mistakes and is passionate about creating excellent products. Now, even for dedicated Windows computer users, Apple’s products are something worth thinking seriously about. When it comes to evoking pure passion among users, there is no company like Apple. The way Apple has launched the iPhone globally has shown that it fully understands how to use the power of the Internet and the media to create global attraction for its new products at very little cost. On October 26, the company will launch its latest version of the OS X operating system, Leopard.

The company’s success has been rewarded on Wall Street; the company now has a market cap of more than 148.2B and its shares are trading at $172.

Another company which has succeeded in creating a global brand in a relatively short time is Google, which was founded on September 27, 1998. Google started as a technology company, and has morphed into a company which understands, and is now revolutionizing the media business. Coming from a very strong technology core base, they like to constantly talk about their technology, even though that is relatively unimportant backend stuff to most people. Very early on, Google figured out that as computing, and now mobile computing grew, more and more data would be accessed from online. The question was: “What was the economic/business models which would support it?” The answer is first search, and then other formats of online advertising. Google strived to make advertising more relevant and less disruptive, and strived to do this all with its Adwords solution.

It has also been a success on Wall Street. Even though expectations were high, it blew past the estimates with its recent earnings announcement , growing the company at twice the growth rate of the growing online ad market.

While Google has continued to have a hard time succeeding in China because of strong competition from Baidu, it is performing exceptionally well in other markets. Compared to their smaller local competitors, US companies continue to have a hard time succeeding in China. Nevertheless, Google continues to make inroads in China.

When talking about large investment amounts, it is easy to forget that the most important part of the equation in brand-building is always people, not marketing dollars or yuan. Buying into Apple and Google would get an inside view into how these leading companies are run.

So what is the best, the smartest way to buy into these companies?

My guess is that the smartest way is to buy Apple and Google shares on the open market and gradually build up enough to get a board seat, where the sovereign wealth fund’s proxies could quietly learn how these companies perform, and find out who are the people who really make contributions to the company. Steve Jobs likes to create the persona that he is Apple and Apple is Steve Jobs, but the truth is not that simple.

Be a smart passive investor, not a dumb active investor. Learn to walk before you run. While it may seem a longer, slower process in the beginning, this is actually the faster, smarter and more economical way to go. Can you think of another way where you earn money while you learn instead spending big chunks?

So to sum up, the benefits of buying into Apple and Google are:

  • Great place to park those extra depreciating dollars and get some appreciation
  • Great way to learn how digital online products and brands are made
  • Great way to find out who the smart movers and shakers are
  • Great way to learn how to become a smart passive investor

If the sovereign wealth fund is doing what they were set up to do, they are already buying Apple and Google shares.

Now that would be real smart…

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.

Getting Past The “China Market” Hype

August 13th, 2007

If there is one thing which never ceases to amaze me, it’s the sheer number of overseas investors seeking entry to China, who have a hard time seeing past the most basic facts and figures about the size of the Chinese market.

Most of these firms are American, which are, generally speaking, more addicted to numeric data than their European and Japanese counterparts. Some statements they frequently quote are:

Looking at China’s economic statistics in these terms, it is very easy for executives who have little or no experience selling products outside their own home markets to think that the potential of the Chinese market is something which will fund their own retirement nest eggs.

The great danger is that more often than not, they are unable to see past these initial assumptions about the Chinese market on the board and senior management level. In fact, as many learn to their own dismay, the Chinese market is complicated, filled with traps to capture uninformed executives who fail to grasp the difficult realities of China’s markets.

Let’s take a look at some of these wrong assumptions, followed by the facts:

  • “The size of the Chinese consumer market is huge.” (True, but for the most part, there is no single national market and no way to distribute nationally; you need to negotiate deals city by city and province by province. Every city and every province wants its own unique distribution deal in order to have uniqueness in the marketplace. The main problem is not high costs, but the amount of time it takes to roll out. While the customer numbers may be huge, revenue per customer/user are usually in fact very low in the beginning for most sectors compared to other more developed markets.)
  • “If I partner with a company with national distribution, then my job will be easier.” (True, but the companies which take on partners are usually the ones who are in trouble. Many of these are state-owned enterprises which lack business marketing skills, and are trying to translate their monopoly charters into revenue with the foreign partner’s help.)
  • “Our product is so good that it will market itself”. (If you believe your own PR in this regard, your company deserves to fail.)

For the most part, the most successful companies in China’s emergent consumer market economy are firms like Suning (in consumer electronics), Shanda (in online gaming and entertainment) and Suntech (in solar energy).

What do these companies have in common? They are new, and while they did have some government backing and connections in their very early stages, they have now transformed themselves into privately-owned businesses with their own management team and CEO. For the most part, these companies are very centrally managed by their founder/entrepreneur. Unless a foreign company is able to present a very strong case for partnering with them, they will prefer to build and distribute on their own. Why should they share their profits and revenues with another company, and help to build another brand which may become a future competitor? After all, that’s how they became dominant in their own sectors; they’re not about to make the same mistake themselves.

As China’s economy becomes more market-oriented, China’s state-owned enterprises are struggling to define their roles in this new economy. It is not enough to have a government-granted monopoly charter; they need to become profitable. This pressure for profit usually comes from the Chinese government’s State Council, which is China’s cabinet.

Their preferred solution is to set up a joint venture with a foreign company, which injects startup capital since the Chinese government, as a matter of policy, does not inject capital into joint ventures, instead offering other fuzzy stuff like “markets” and “connections” into the joint venture.

Most of these joint ventures fail because the two sides fail to do the hard work to insure that there is a complete alignment of interests and accountability for their investment in the JV. Most of the time, I blame the foreign partner’s inability to see past the market hype and think and discuss the whole project through with the Chinese government partner and clearly defining which partner has responsibility to perform what needs to be done.

The endless procession of foreign companies who come to China and throw good business sense to the winds without performing proper due diligence in order to secure a footing in the “China market” never ceases to amaze me. Why is it they seemingly only do this in China? Do they think that the Chinese will throw them out of the country for asking good legitimate business questions?

Chinese SOEs are in particular need of modern management skills, especially in the areas of marketing, sales and cost accounting. Foreign JV partners would in fact be helping the Chinese companies reform by holding them accountable to reach specific business goals. The SOEs have strong connections and resources in a potentially large market.

It is only when both sides are honest about their goals and expectations that they can succeed.

China Sets US Interest Rates Now, Not the Fed

August 11th, 2007

This is the opinion of Paul Craig Roberts, who previous served as Assistant Secretary of Treasury during the Reagan administration, and is often quoted as the “father of Reaganomics”. (You can read the Wikipedia entry about him here.)

Recently there has been discussion about China’s threat to use the “nuclear option”, or and basically destroying the value of the US dollar as a global reserve currency by dumping more dollars on the markets than they can absorb in a short time, forcing the dollar into a free-fall.

The prevailing wisdom among US economists is that China would not make such a move, as the damage to China’s own economy would be too great. Roberts rebuts this claim saying that

American economists make a mistake in their reasoning when they assume that China needs large reserves of foreign exchange. China does not need foreign exchange reserves for the usual reasons of supporting its currency’s value and paying its trade bills. China does not allow its currency to be traded in currency markets. Indeed, there is not enough yuan available to trade. Speculators, betting on the eventual rise of the yuan’s value, are trying to capture future gains by trading ‘virtual yuan.’ The other reason is that China does not have foreign trade deficits, and does not need reserves in other currencies with which to pay its bills. Indeed, if China had creditors, the creditors would be pleased to be paid in yuan as the currency is thought to be undervalued.

In addition, he refutes the claim that China would lose US markets with such a move.

The notion that China cannot exercise its power without losing its US markets is wrong. American consumers are as dependent on imports of manufactured goods from China as they are on imported oil. In addition, the profits of US brand name companies are dependent on the sale to Americans of the products that they make in China. The US cannot, in retaliation, block the import of goods and services from China without delivering a knock-out punch to US companies and US consumers. China has many markets and can afford to lose the US market easier than the US can afford to lose the American brand names on Wal-Mart’s shelves that are made in China. Indeed, the US is even dependent on China for advanced technology products. If truth be known, so much US production has been moved to China that many items on which consumers depend are no longer produced in America.

Roberts then builds a case for China’s dumping dollars as a reaction against US pressure for revaluing the yuan, refuting claims that this is an impossible scenario.

Consider that if China were to increase the value of the yuan by 30 percent, the value of China’s dollar holdings would decline by 30 percent. It would have the same effect on China’s pocketbook as dumping dollars and Treasuries in the markets.

Consider also, that as revaluation causes the yuan to move up in relation to the dollar (the reserve currency), it also causes the yuan to move up against every other traded currency. Thus, the Chinese cannot revalue as Paulson has ordered without making Chinese goods more expensive not merely to Americans but everywhere.

Compare this result with China dumping dollars. With the yuan pegged to the dollar, China can dump dollars without altering the exchange rate between the yuan and the dollar. As the dollar falls, the yuan falls with it. Goods and services produced in China do not become more expensive to Americans, and they become cheaper elsewhere. By dumping dollars, China expands its entry into other markets and accumulates more foreign currencies from trade surpluses.

Basically, Roberts makes a strong case for the argument that the US no longer has leverage over China and global financial markets the way it used to. You can read his whole article here.

Have we reached a tipping point in American power and global influence?