Wednesday, June 15, 2005

Fishman Article on China

Excerpts from "How China Will Change Your Business: Fourteen things every entrepreneur should know about the capitalist explosion heading our way.
From: Inc. Magazine, March 2005 | By: Ted C. Fishman

(Mostly observations, not prescriptions. Our leaders, on both sides of the aisle, are clueless. We're on our own, and this is a good primer on the big picture--Carlos)

1. China's economy is much larger than the official numbers show.
2. The growth of China's economy has no equal in modern history.
3. China is winning the global competition for investment capital.
4. China can be a bully.
5. China's economy is an entrepreneurial economy.
6. The most daunting thing about China is not its ability to make cheap consumer goods.
7. China is closing the research and development gap -- fast.
8. China now sets the global benchmark for prices.
9. China's growth is making raw materials more expensive.
10. No company has embraced China's potential more vigorously than Wal-Mart.
11. There are hidden costs associated with doing business in China.
12. Piracy is a problem.
13. China's heavy buying of U.S. debt has lowered the cost of money in the U.S.
14. Americans and Chinese have become reliant on each other's most controversial habits.

1. China's economy is much larger than the official numbers show. In 2003, China's official GDP was $1.4 trillion. By that measure, it was the seventh-largest economy in the world. As with nearly all economic statistics from China, however, that measure is suspect. One reason the real number may be much higher is that, in competition for development funds, local Chinese authorities have considerable incentive to underreport their growth rates to the nation's central planners. Another reason is that the government measures only China's legal economy. Its underground economy, made up of both unsavory businesses and more mundane ones that lack a government stamp (and tax bill), is enormous but uncountable.

2. The growth of China's economy has no equal in modern history.... Since China set about reforming its economy a generation ago, its GDP has expanded at an annual rate of 9.5%. Countries in the early stages of economic reform often come up fast, but not like China. The country is closing in on a 30-year run during which its economy has doubled nearly three times. Neither Japan's nor South Korea's postwar boom comes anywhere close. Nicholas Lardy, an economist at the Institute for International Economics, notes that China grew mightily even during the worldwide economic doldrums of 2001-02.

3. China is winning the global competition for investment capital. One reason China's economy is growing so fast is that the world keeps feeding it capital. According to Japan's Research Institute of Economy, Trade and Industry, one-third of China's industrial production was put in place by the half-trillion dollars of foreign money that has flowed into the country since 1978. In 2003, foreigners invested more in building businesses in China than they spent anywhere else in the world. The U.S. used to attract the most foreign money, but in 2003 China took a strong lead, pulling in $53 billion to the U.S.'s $40 billion.

With money comes knowledge. The catalytic role of foreigners in the country is still growing quickly; every day China receives a river of European, Asian, and American experts in manufacturing, banking, computing, advertising, and engineering. In 2003, the exports and imports by foreign companies operating in China rose by over 40%. More than half of China's trade is now controlled by foreign firms. Many of these import goods into the country that they then manufacture into exports. Foreign companies have pumped up China's trade volume enough to make it the third-largest trading country in the world, behind the U.S. and Germany and now ahead of Japan.

4. China can be a bully. China can spend, it can hire and dictate wages, it can throw old-line competitors out of work. In just a three-year period from 2000 to late 2003, for example, China's exports to the U.S. of wooden bedroom furniture climbed from $360 million to nearly $1.2 billion. During that time, the work force at America's wooden-furniture factories dropped by 35,000, or one of every three workers in the trade. China now makes 40% of all furniture sold in the U.S., and that number is sure to climb.

5. China's economy is an entrepreneurial economy. China's industrial competitors, including the U.S., often misapprehend the source of China's productive strength. They fear that another centrally governed, well-planned assault on strategic industries is being plotted in Beijing. The world has already seen how effective the Japanese, Koreans, and Taiwanese can be when they focus on sectors they mean to conquer. Even Chinese government planners like to talk as though they are aping the centrally coordinated, government-financed assaults on strategic global industries that their Asian neighbors have pulled off over the past 40 years. However, in looking at how Chinese businesses really take shape -- locally and opportunistically -- Kellee Tsai, a political scientist at Johns Hopkins University and a former analyst at Morgan Stanley, argues that nothing could be further from the truth. For a world fretting over Chinese economic competition, the entities to fear are not government planners but enterprises that spring on the scene lean and mean, planned and financed by investors who want to make money quickly.

6. The most daunting thing about China is not its ability to make cheap consumer goods. The American economy won't crater just because the Chinese can produce sofas and socks for less than we can. The Japanese, for their part, have lost the television business. The Italians are losing the fine-silk business. Consumer goods trade on the surface of the world's economy and their movement is easy for the public to watch. The far bigger shift, just now picking up steam, is occurring among the products that manufacturers and marketers trade with each other: the infinite number and variety of components that make up everything else that is made, whether it is the hundreds of parts in a washing machine or computer or the hundreds of thousands of parts in an airplane.

The next question is whether any commercial technology is beyond an imminent challenge from China. The manufacture and sale of integrated chips is ... soaring, along with healthy gains in China's software and information-services markets. Then again, every section in the directory has grown, including biotechnology, semiconductors, and Internet development, areas in which Chinese firms have newly established themselves, many now in partnership with the world's leading technology-driven companies.

7. China is closing the research and development gap -- fast. ... Last year, China spent $60 billion on research and development. The only countries that spent more were the U.S. and Japan, which spent $282 billion and $104 billion, respectively. But again, China forces you to do the math: China's engineers and scientists usually make between one-sixth and one-tenth what Americans do, which means that the wide gaps in financing do not necessarily result in equally wide gaps in manpower or results. The U.S. spent nearly five times what China did but had less than two times as many researchers (1.3 million to 743,000). China's universities and vocational schools will produce 325,000 engineers this year -- five times as many as the U.S.

8. China now sets the global benchmark for prices. Big news can be found in little places. In its November 2003 circular, a dryly written four-page publication, the Chicago Federal Reserve Bank noted complaints from American makers of automotive parts that "automakers had been asking suppliers for the 'China price' on their purchases." The bank's analysts observed that U.S. suppliers had also been asked by their big customers to move their factories to China or to find subcontractors there.

It is plainly understood that asking suppliers to lower prices is merely another way of telling them they ought to be prepared to meet the best price out of China, even if they are making their products in Japan or Germany. General Motors, which buys more than $80 billion worth of parts a year, now has a clause in its supply contracts that gives its supplier 30 days to meet the best price the company can find worldwide or risk immediate termination.

9. China's growth is making raw materials more expensive. Even as China puts pressure on U.S. manufacturers to lower prices, it's squeezing them from a different direction. Its voracious demand for raw materials has caused prices to spike. Copper prices jumped 37% last year, aluminum and zinc both rose about 25%, and oil was up 33%. In 2003, according to the calculations of Stephen Roach, chief economist at Morgan Stanley, the Chinese bought 7% of the world's oil, a quarter of all aluminum and steel, nearly a third of the world's iron ore and coal, and 40% of the world's cement. The trend is for bigger amounts yet to come.

The squeeze is leaving U.S. manufacturers with no alternative but to become more productive. Better machines, software, and advanced management techniques, for instance, now mean that U.S. companies on average produce far more per worker than they did a quarter of a century ago when manufacturing employment was high. From 1977 to 2002, productivity throughout the U.S. economy grew by half, but in manufacturing it more than doubled. Surprisingly, despite losing huge numbers of workers, U.S. manufacturers actually finished 2003 making more stuff than they did in 2001. Output was up, if only by half a percent.

10. No company has embraced China's potential more vigorously than Wal-Mart. And no company has been a bigger catalyst in pushing manufacturers to China. Estimates of how much of Wal-Mart's merchandise comes from abroad today range from 50% to 85%. Chinese factories are, by far, the most important and fastest-growing sources for the company. In 2003, Wal-Mart purchased $15 billion worth of goods from Chinese suppliers. A whopping portion of between 10% and 13% of everything China has sent to the U.S. winds up on Wal-Mart's shelves. Writing in The Washington Post, Peter Goodman and Phillip Pan reported in February 2004 that "more than 80% of the 6,000 factories in Wal-Mart's worldwide database of suppliers are in China." The company has 560 people on the ground in the country to negotiate and make purchases.

11. There are hidden costs associated with doing business in China. Companies that engage with China must expect pressure to transfer their technology and thus create their own competition in the country. The Chinese use the carrot of their vast market to extract concessions from foreign firms that will help build China's industrial might. It is a policy worthy of grudging admiration. When viewed from the Chinese side, it has a long record of success.

Motorola virtually invented China's mobile-phone market. Its corporate archives show that the company knew that eventually the transfer of technology to China would sow formidable rivals. Nevertheless, Motorola decided its best strategy was to get into China early and to bring its best technology. The proof today is in the size and efficacy of the country's mobile communications network: Calls get through to phones in high-rises, subway cars, and distant hamlets -- connections that would stymie mobile phones in the U.S.

What no one at Motorola anticipated was how crowded the Chinese market would become. Nokia and Motorola now battle for market share in the Chinese handset business. German, Korean, and Taiwanese makers figure strongly. And all these foreign brands are now facing intense competition from indigenous Chinese phone makers. More than 40% of the Chinese domestic handset market now belongs to local companies such as Ningbo Bird, Nanjing Panda Electronics, Haier, and TCL Mobile. The domestic makers have become so strong that when Siemens found its mobile handset business in China wanting, it joined with Ningbo Bird to gain both low-cost manufacturing and a developed distribution channel. Yet Motorola can't exit the Chinese market. If it did, says Jim Gradoville, Motorola's vice president of Asia Pacific government relations, the Chinese companies that emerged would be the leanest and most aggressive in the world, and a company like his would have no idea what hit it. So Motorola stays. Already the largest foreign investor in China's electronics industry, Motorola plans to triple its stake there to more than $10 billion by 2006.

12. Piracy is a problem. Foreign companies have little defense against even outright theft of their technology in China. China's failure to police intellectual property, in effect, creates a massive global subsidy worth hundreds of billions of dollars to its businesses and people. By investing in the country's manufacturing infrastructure, by providing the expertise, machines, and software China needs to produce world-class products, the world is also helping assemble the biggest, most sophisticated, and most successful "illegal" manufacturing complex in the world.

Seen another way, China's loose intellectual property rules turn the tables on the Western colonial powers and the Japanese who throughout the nineteenth and early twentieth centuries violated China's land and people. As China grows into a great power, the wealth transferred into the country by expropriating intellectual property will propel it forward.

13. China's heavy buying of U.S. debt has lowered the cost of money in the U.S. In the first half of 2004, China's total foreign exchange reserves topped $460 billion. In size, that puts China's cumulative dollar account at roughly equal to a third of its gross domestic product. If China simply spent its dollars, it would flood the world market with American currency and drive the dollar down. But China, no fool, is not interested in pushing the dollar down. So instead of selling its dollars, it lends them back to the U.S.

As long as China is an aggressive lender, Americans -- whether borrowing for their own private purchases or acting in the roles of taxpayers -- can borrow money at lower rates than they would otherwise have to pay. Much of the recent boom in real estate prices in America, especially in the East and West Coast markets, is attributable to these low rates.

14. Americans and Chinese have become reliant on each other's most controversial habits. The Chinese need a low-priced currency to keep their export machine going and create jobs. But maintaining the yuan's low price also means that Chinese consumers are stuck with a currency that would otherwise buy more for them on the world market. China's diligent savers suffer too since their bank deposits are tied up in accounts that earn low government-mandated rates of return, as the government, in effect, siphons off money from savers to maintain its currency peg.

Relatedly, China's vast export earnings earn less than they ought to when they are invested in U.S. debt securities that offer modest yields, when investments in the Chinese economy can return 10 times as much (albeit on riskier terms). Seen from that view, the people of China, who earn on average just one-fortieth what Americans do, are indirectly subsidizing the insatiable shopping of Americans, who acquire ever more goods at the same time that Chinese consumers are hampered from buying goods from abroad.

The obverse of this peculiar relationship is that China lends America all the money it needs to spend itself silly. The cycle of codependency, which former U.S Treasury Secretary Lawrence Summers labels a "balance of financial terror," isn't sustainable. The U.S. cannot take on ever-bigger debt and amass huge trade deficits indefinitely. In the worst scenario, the U.S.'s willingness to fritter away its national wealth to finance private consumption and unproductive government spending would extract a permanent price on the economy, sending the U.S. in a downward spiral that would be hard to escape.

How can the U.S., perhaps with its traditional allies, adjust to a competitive challenger that has strengths unlike any other that America has faced? Are the transfers of talent, technology, and capital part of an inevitable dynamic? Or does the U.S., or any other country, have the power to shape a future in which everyone prospers?

Americans looking for answers and action must also find a way to move America's leadership to see China's rise as every bit as worthy of national attention as the rumblings in more obvious political hot spots. While all eyes turn to the so-called clash of civilizations between Islam and the West, China will have the more profound impact on the world in the long run.


Blogger Other Lisa said...

This is one of the reasons I study Mandarin...

June 17, 2005 2:37 PM  
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October 08, 2005 7:29 AM  
Anonymous Anonymous said...

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October 11, 2005 9:28 PM  
Blogger CODYLDHU said...

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January 08, 2006 4:35 PM  

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