Internet Crackdowns As An Economic Performance Indicator

July 16th, 2010

In China, the Chinese government is obsessed with maintaining economic growth at a high level. This is because a large part of the Chinese government’s implicit mandate with the Chinese people is guaranteeing continuing growth, which leads to a better standard of living. If growth slows down, then the whole basis of government legitimacy is challenged. This is why leading economists such as Michael Pettis, a very astute observer of the Chinese economy, believe that the Chinese government will continue their outbound investments in the US, for example.

Now for many other political observers of China, there is the widespread belief that Internet censorship is a human rights and free speech issue only, and something which is unrelated to economics. For them, this is an argument about humanitarian values which should be shared across the world. In the past few days, there has been a new crackdown on Twitter clones and some outspoken blogs in China have been deleted, according to this story in the Washington Post.

But what if economic performance and Internet crackdowns are in fact related, because the government fears outspoken criticism if economic indicators are much lower than the goals they have committed to and seek?

If that is the case, then the internal economic numbers which the government is seeing are a better indicator of how the people feel and will behave in the short-term, and bad numbers would make the government want to crack down pre-emptively, heading off potential dissent before the news becomes widespread.

When you put this into the Chinese context of domestic politics, and see that the Chinese leadership will be handed over to a new president and premier in 2012, what is happening on the Internet makes perfect sense. The current leadership of President Hu Jintao and Premier Wen Jiabao are due for retirement then, and will hand over leadership to a new leadership team. With two years left in their term, it is safe to say that world markets look unstable, with another wall of debt about to hit the US and Europe in the next year, further dampening consumer spending in the west. How can they manage a smooth handover without things getting unstable?

In China, there are early signs that there is an excess of white collar workers in the cities, and a shortage of blue collar workers in the factories, which is why factory workers have the leverage to slow down work or even go on strike. The traditional Chinese view of education is that the more educated you are, the better, but this view is being challenged now, and this view will sharpen over the next decade. China’s urbanization will mean more white collar workers will be looking for work in the cities, and they will have a harder time finding jobs. At the same time, this under-employed workforce will be aging quickly. Already, there are signs that a new subclass, the “ant people” are emerging, living in separate gated communities. Will this turn into China’s version of Brazil’s notorious favelas? This is the exactly the kind of situation the Chinese government wants to avoid. The gap between the urban rich and poor will become more marked.

As growth slows, the greatest challenge to the government will become readjusting the hopes and dreams of the Chinese people to a new reality of more moderate growth. This is an unprecedented challenge.

Is this a formula for social instability? You bet!

And where will they vent? On the Internet.

How will they potentially organize by spreading inflammatory remarks? On the Internet.

Seemingly this is a China problem, but as the world economy slows down, it will become a problem for other governments too. Free speech is taken for granted in good times, but in hard times, when social stability is at stake, it becomes another story.

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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