Will India Challenge China? Not yet.

Last month my wife and I took our first ever trip to India. Since that time I have struggled to put into words what I learned on our trip – not only about India, but also about China. Since today is the last day of 2011, I have determined that my latest thinking on this topic, however crudely formed at this point, is going up on the blog today.

India Gate, Delhi

So what does China have to do with India? More importantly, you may be asking, how could one hope to learn anything about China by visiting a completely different country?

Why India?

Aside from the fact that I thought India would be an interesting place to visit, I had begun to notice over the past year news stories, blog posts and twitter discussions about whether India would ever challenge China economically, militarily and/or diplomatically.

One book I read earlier in 2011 was Robert Kaplan's Monsoon, a fascinating historical approach to explaining why the Indian Ocean will become the world's most contested region, and how China and India are already competing for influence. (Kaplan also leads the reader to wonder a.) whether the US understands the importance of this region and b.) even if the US gets it, whether the US will have either the will or the ability to maintain its influence.)

The question of whether China's influence in the region will increase is no longer contested, but many people – including some long-time China watchers such as me – see India as a potentially credible rival to China. India has a large land mass, the world's second largest population and an economy that has consistently turned in upper-single digit economic growth for most of the past two decades. India and China also share a long and contested border, with both countries occupying lands claimed by the other, and as a result, the level of trust between the two has always been fairly low.

Regardless of whether India could become a credible rival, it is easy to see that many of the necessary ingredients for a rivalry are there. And given what I know about China – that it fully intends to return to its historical role as regional (if not global) hegemon – I wanted to see for myself whether India might truly be on the cusp of challenging China's ambitions.

So why might I have expected to learn anything about China while in India? Perhaps it is because China is the first country in which I ever spent significant time abroad. Ever since the mid-'90s, every other country I have visited has further illuminated my view of China.

Since 2000, when my employer sent me to Japan for a couple of years, I have viewed China slightly differently. To give but one small example, having been a waiter in college, I had always thought that service in China was poor because no one tipped in restaurants. After my first dinner in Japan, not only was I amazed by the friendly and efficient service, but also by the fact that the Japanese don't tip in restaurants either. There was clearly a much deeper cultural or sociological explanation for the disparity in service levels between China and Japan.

Will India challenge China?

So, back to the first burning question that drove me to India, the question of whether India will be a credible rival to China. The short answer to this question, I am disappointed to admit, is no – certainly not in the near future, and not without China self-destructing from the inside.

As thrilled as we were to have arrived at the clean new terminal of Delhi Airport, my wife and I were simply dumbstruck by the the poverty, filth and chaos we witnessed during the hour-long ride to our hotel. Delhi makes Beijing look clean and orderly by comparison (a fact that cannot have been lost on any Chinese leaders who have visited India). And while I reserved judgment on that first day, the remainder of the two weeks we spent in India further confirmed that India is not quite ready for prime time.

Chandni Chowk Bazaar

This is not to say that India has no hope at all, but a lot of what I saw on the ground, combined with what one may easily learn about politics in India by reading the news, leaves me to believe that India has much further to go if it ever hopes to catch up with China. I simply never imagined India's overall development gap with China would be so wide.

I also came away from India with a new level of appreciation and respect for the accomplishments of China. While I don't believe China's accomplishments excuse the lack of personal freedoms and rampant abuses of human rights, one cannot help but admire the speed with which China has pulled itself out of a deep hole of poverty.

Traveling in India and China

Traveling in China, while having improved quite a bit over the past two decades is still a bit of a grind, and in some areas it has become worse. When there were fewer people traveling by air back in the '90s, there were also far fewer unexplained flight delays than there are now.

That said, we found traveling in India to be even more difficult. Travel agencies and airline ticket offices tend to close on Sundays so if an emergency arises (say, for example, one gets food poisoning – don't ask me how I know about this) and you need to change your travel plans, just be sure it doesn't happen on a Sunday. (Apparently the planes do still fly on Sunday.)

Also, trains in India are apparently affected by fog. The day we left Delhi for Agra, our train was two hours late, which actually wasn't bad considering many trains were as much as six or seven hours late that day.

New Delhi Train Station

This connection between train travel and weather would not have occurred to me, but apparently train engineers in India need to have a certain distance of visibility before a train can travel. Having traveled on trains in China in all kinds of weather, I don't think this is the case there, though I could be wrong. I mean, if all trains follow their appointed schedules, and all trains are connected via radio to each other and to a central dispatch, avoiding collisions shouldn't be rocket science.

Of course, one can easily avoid the hassles of air and train travel by hiring a car and driver, but it can be quite expensive, particularly if it is arranged by your hotel, which (as we later realized) has no problem doubling the price of the car for their own profit.

Corruption

And in terms of scams and general corruption, I used to think the Chinese were masters at cheating foreigners, but they have nothing on the Indians I encountered on the tourist track. By comparison, the Chinese are rank amateurs. At every turn – particularly in north India, but less so in the south – we encountered people who, on the pretense of being friendly and inquisitive, wanted nothing more than to separate us from our money while providing nothing of value in return.

A market in central New Delhi. Where were all the women?

In all fairness, I must emphasize that these people were gathered in massive numbers around the areas frequented by tourists. Because we did not really experience the everyday lives of average Indian citizens, I cannot comment on whether such corruption affects their lives to a similar degree. However, if the many Bollywood movies I have watched are any indication, perhaps the corruption for the average Indian is just as bad though taking on different forms.

But you should go to India anyway...

While my post thus far has focused on some of our negative experiences in India, the truth is that my wife and I loved India. The amazing sights we saw, the outstanding food we ate, and the smart and honest people whom we encountered along the way combined to make the whole experience worthwhile.

If you have ever considered traveling to India just to see the sights, we can attest that it is absolutely worth the effort. (And this comes from a couple who have seen many of the amazing sights that China, Vietnam, Japan and California have to offer.) Though we were disappointed to find our view of the Taj Mahal completely obscured by pea-soup fog, this in no way diminished our experiences in seeing the Qutb Minar, Humayun's Tomb, the Red Fort, Agra Fort and the Amber Fort near Jaipur, among others.

The Taj Mahal (It's back there somewhere.)

We also experienced fantastic service aboard a kettuvallam boat on the backwaters of Kerala while dining on outstanding Kerala cuisine and learning about the lives of the people who farm and fish in the area. And probably our best experience was at a farm homestay near Kochi where we enjoyed the warm hospitality of a world-wise Syrian Christian family and engaging conversation around the family dinner table.

The crew on our kettuvallam cruise, Lake Vembanad, Kerala

All of this should come as no surprise to anyone who has traveled to more than a handful of foreign countries. The world is a big place, and every country has both its pluses and minuses. While I still have yet to visit most of the world's countries, in every country I have visited, I have discovered uniquenesses that make my travels worthwhile. And though India did not live up to my (unreasonable) expectations, I have no regrets for having visited, and I will most certainly return. (While I was able to touch the Taj Mahal, I still have yet to see it!)

Evolving views on India vs China

This has been a difficult blog post for me to write, if for no other reason than that I really, really wanted India to be the credible rival that China needs to have in Asia. Also, since returning from India, my wife and I both have found that our views are evolving as we continue to ruminate over our experiences there and compare them to our experiences elsewhere.

And I must also emphasize that this does not arise from a desire to “keep China down” as China's media often likes to claim whenever foreigners disagree with China's government. As I stated before, I have an even greater appreciation for China's accomplishments to date. Yet at the same time, it is somewhat unnerving to the free world that a big, powerful country such as China may have figured out a way to build prosperity without personal freedoms (note the emphasis on “may”). It makes many people uncomfortable that this kind of government aspires to regional hegemony and world leadership.

I would argue that no one really has a desire to “keep China down,” but that many do have a desire to keep authoritarianism down. If China were to demonstrate its concern for human rights, few would have a problem with its asserting influence around the world. (Though one might argue the same for the United States.)

And this is precisely why my hopes for India were so high. I very much wanted to see for myself that a democratically-led government could provide for its citizens both freedom and economic prosperity, and act as a counterweight to the other big country in the region that only wants to provide the latter. But what I saw is that, similar to America, India's prosperity is limited to a small sliver at the very top of society. The middle class experience stagnation while the poor are just trying to keep their heads above water.

It would be easy to blame democracy for the disparity between China and India, but I believe that is too simplistic of an answer. (Naturally, this is the lesson that China's leaders will choose to take from their own comparisons with India.) There are many other differences between China and India that cannot be ruled out as factors affecting the countries' trajectories of development.

The most obvious difference is demographic. Whereas China is quite homogeneous, India is a patchwork of ethnicities, religions and languages. Without going into too much detail, I can only say that it is a surprise to me that India has remained a cohesive unit since 1947. The fact that it didn't break into dozens of rival states is a testament of the determination of independent India's first leader Jawaharlal Nehru. Love him or hate him, one cannot deny that he laid the foundation for modern India – both good and bad.

Since this blog post is already far longer than most people will bother to read, I will end it here and simply note that my thinking on this topic is far from complete. Scholars far more brilliant than I have tackled this topic of comparative modernization, and have yet to produce anything more than hypotheses (some more plausible than others).

The one thing I know, however, is that I will most certainly spend time in both India and China again in the future. I see great value in understanding both countries and how their political systems affect the lives of real people.

Happy 2012, everyone!

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EDIT (4 Jan 2012)
Dan Harris at ChinaLawBlog, one of my favorite China blogs, linked to my India-China post and had some interesting comments of his own -- some of them way too kind, but also some valid criticism. Since his site generates a lot more traffic than mine, his post generated a lot more comments than mine (although I believe this post sets the all-time record for comments at ChinaBizGov.)

Check out Dan's post and also the comments that follow. Some people are critical of the fact that we would even compare China and India, but I think the fact that so many people took issue with this post tells me that there really is no consensus answer on this topic. There are a lot of great ideas and food for thought in the comments (along with the usual anonymous sniping from the sidelines).

If you're really interested, here's another related post on this topic that I came across today. It's written by someone with a great deal more experience in both China and India than me, and he includes a lot of facts and figures to back up his assertions.

Hold on to your lugnuts! It's time for a Trade War!

The Wall Street Journal is reporting today that China is preparing to levy duties on certain autos imported from the US. This would be on top of the 25 percent duties that China is still allowed to levy under its WTO commitments.

China's Ministry of Commerce said in a statement late Wednesday that it will levy antidumping and antisubsidy duties on imports from the U.S. of some vehicles with engine capacities above 2.5 liters beginning on Thursday and lasting through the next two years. ...

The ministry said several U.S. companies, including General Motors Co., Chrysler Group LLC and the U.S. arm of Honda Motor Co., engage in dumping and subsidizing. The statement said the move would also affect cars made by the U.S. arms of Mercedes-Benz and BMW AG, though it said their level of dumping was smaller.

Note that China's Commerce Ministry singled out not only the traditional US automakers GM and Chrysler, but also the US arms of Honda, Mercedes and BMW.

While China could have plausibly argued that GM and Chrysler benefit from government subsidies due to the bailouts these two companies received, they instead chose to make this about all cars with engines larger than 2.5 liters made in the US (but not in Japan or Germany!).

Does anyone think the US Congress will choose to view this as any less than an attack on the livelihoods of American workers -- and in an election year no less? Of course, Congress cannot portray themselves as innocents in all of this as Congress has already singled out China's solar panel industry for US-imposed tariffs. Then again, Congress can point to China's currency...

And on and on it goes. One thing I learned in grad school about wars (the kind in which people shoot at each other) is that it is nearly impossible to identify who started it. No matter which incident one side points to, the other side can go further back in history to identify another.

If we look at this incident only with regard to China's auto industry, it is also easy to see a kind of pattern here. Back in 2009, when China launched the stimulus heard round the world, they chose to subsidize consumer purchases of vehicles with engines smaller than 1.6 liters.

Why 1.6 liters? Because the foreign automakers that were dominating China's auto market had very little to offer in the small car segment. That subsidy was intended to boost sales of Chinese-branded cars.

Of course, the foreign automakers didn't stand still. Many of them already had small cars in the pipeline, so they got them to market faster -- just in time for China to cancel the subsidy toward the end of 2010.

Why are the import duties now focused on 2.5 liters? Because this is an area in which the foreign automakers pretty much own the market. This effort to make these imports more expensive may ideally (from China's point-of-view) accomplish two things: 1) make Chinese consumers more likely to consider a less expensive Chinese-branded car, and 2) make foreign automakers consider moving more assembly of their larger models to China.

In reality China's new tariff may not accomplish either purpose. For one, the Chinese consumers who are more interested in these larger cars (as the WSJ article points out) are less price sensitive anyway. They are already interested in these large foreign brands because they perceive them to have higher quality. In addition, because the volume of these larger cars in China is still comparatively small, it is highly doubtful that much, if any, of their production would be moved to China. (Perhaps that second one is a straw man argument.)

So what does China really stand to gain? Not much, really. In the end, China will get the trade war that it has been warning us about for years, and its home-grown automakers will still face a quality gap with their foreign partners/competitors.

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In case you're wondering where the picture at the top came from:

China, without all the paranoia

I recently returned from a trip to Taiwan as part of an American Young Scholars' Delegation. Pretending that I could still qualify as “young,” I joined ten other American scholars as a guest of Taiwan's Ministry of Foreign Affairs (MOFA) for a week of meetings and sightseeing.

The purpose of this trip was for Taiwan to introduce itself to a handful of foreign scholars who previously had little contact with Taiwan, but who were interested to see the country up close. About half of our delegation were China scholars, with the rest having interest in aspects of Taiwan's culture, politics or society related to their own research.

As is my custom, on the first morning after the trans-Pacific flight, I hit the streets for a quick run and my first look at Taipei as the sun was rising. The area around our hotel in Taipei felt much like parts of Hong Kong or Shenzhen: green and well-swept.

Whenever I run in China, I am accustomed to being either stared at or ignored, but I was surprised when two different people greeted me during my first run in Taipei. One security guard enjoying a cigarette gave me a big wave and a deep-voiced “ni hao.” Another middle-aged Chinese man greeted me with broad smile, a nod and an enthusiastic “good morning!”.


In hindsight, I guess I shouldn't have been so surprised by the openness and friendliness of strangers on the streets in Taiwan. Our entire itinerary was intended to impart that impression. Everywhere we went, we were greeted with openness and a willingness to answer all but the most sensitive of questions. (I'll forgive the Deputy Minister of Defense for not fully answering Katherine's question about Taiwan's strategy for defending the Taiwan-held Jinmen [Kinmen] island against an attack by the mainland.)

And while no one chose to dwell on the negative aspects of Taiwan's politics, no one shied away from the facts that fistfights have occurred on the floor of the legislature in the past or that Taiwan's former president now serves a prison sentence for corruption. Indeed, on the day we visited the Legislative Yuan, there was a protest taking place on the street out front. No problem for us though: we just went around back. We learned that Taiwan has been continuously developing its own democratic system for the past two-plus decades, and that, despite the occasional chaos, despite the international isolation, and despite the ever-present threat of big, bad China next door, Taiwan's people have a say in how their lives are run.

Contrast this trip with, well, every trip I have ever taken to China. While the average Chinese citizen can be as open and friendly in private as the average citizen of Taiwan is on the street, there is a stark difference in the general atmosphere. (And I'm not just talking about China's awful pollution.)

Though it is hard to describe in concrete terms, there is a heaviness in China that one feels as soon as one steps off the plane – a sense that one must be careful about what he does, what he says and where he goes. (And any Chinese government official reading this is saying to himself, “well, of course! That's how it's supposed to work!”)

Despite months and months of trying desperately to get even the lowliest bureaucrat on the mainland to discuss China's auto industry with me during my field research a few years ago, out of over 100 interviews, I only managed to interview a single government official. (Though I did talk to several people who work in government-controlled “NGOs”.) And among those whom I did manage to interview, only a few were willing to delve very deeply into the political forces that have shaped China's industrial planning. Even some expatriates with whom I met were scared to talk openly with me. (One expat even demanded that I return his name card after the interview!)

Another surprise during our trip came in our visit to the American Institute in Taiwan (AIT), the de facto embassy of the United States in Taiwan. Having visited a few US consulates on the mainland, I thought I had an idea of what to expect, and indeed AIT had that familiar smell of an old church with a pot of coffee brewing somewhere. But our meeting with AIT officials (our Taiwan MOFA minder remained outside) revealed a surprising level of enthusiasm. In contrast with the bunker mentality I have encountered among bureaucrats at US consulates on the mainland, these folks made no attempt to conceal their enthusiasm, indeed, their advocacy, for Taiwan and all it stands for.

This is not to say that our entire trip was propaganda-free. After all, Taiwan, just like the mainland, also has an agenda. But unlike the mainland, that agenda doesn't include the continued rule of an unelected government, the stifling of free speech, the occupation of, or claim to, territories that do not wish to be a part of the larger whole.

What Taiwan wants is quite simple. They want the rest of the world to know how open and transparent their system is, how much freedom their people enjoy, and how much like the rest of the developed world Taiwan is. In short, the whole purpose of Taiwan's Ministry of Foreign Affairs is to run out the clock. To use a basketball analogy, the task of MOFA is to keep the ball in play, and to keep the other side from getting their hands on the ball. I think the best hope is that China will eventually change into something Taiwan wants to be a part of.

Taiwan has been effectively isolated in the world by China, but Taiwan's diplomats are doing the best they can to let the rest of the world know they exist and that they have a society worth preserving in its present state. And judging by some of the results, Taiwan's efforts are paying off. To cite but one example, the citizens of Taiwan now enjoy visa-free travel to 124 countries around the world compared to only 34 for citizens of the PRC. (I don't know how many countries US citizens can travel to visa-free, but I'm certain it's fewer than Taiwan's citizens enjoy.)

There are, of course, downsides to Taiwan's position. The question of whether Taiwan should declare de jure independence from China or adhere to the status quo dominates Taiwan's politics – to the extent that important domestic issues often fail to get the attention they deserve. National elections tend to be primarily about a candidate's position on cross-strait relations.

Also, there appears to be some confusion around identity in Taiwan, and this confusion revealed itself in some of the language used. What are the people who live on Taiwan supposed to call themselves? Are they Chinese? Are they Taiwanese? The former may be confused with citizens of the PRC. The latter may be confused with aboriginal people who lived on Taiwan for thousands of years before the mainlanders arrived with Chiang Kai-shek in 1949. One of our tour guides kept using the awkward-sounding term, “Taiwan people.”

When we visited the National Library, I noticed that their “Center for Chinese Studies” called itself “漢學研究中心”which could literally be translated, “center for the study of the Han people.” But again, this excludes the aboriginal people who have lived on Taiwan for millennia. And the Palace Museum (which is a must-see for anyone visiting Taiwan) contained mostly relics that had been transported from the mainland, and a history timeline of dynasties presented as if it were Taiwan's own.

I have no suggestions for how Taiwan should address these issues, and in fact, I'm not certain that these issues are really all that important compared to the existential issue Taiwan faces with the ever-present threat of an angry mainland. And the mainland, whose Communist Party has painted itself into a corner with its irredentist claims to Taiwan, really has no way out but to persist with those claims.

Nor do I have any suggestions for the US in its Taiwan policy, other than to stay the course, maintain ambiguity and occasionally ensure that the security balance doesn't tip too far in the direction of the mainland. Taiwan doesn't want to give up its freedoms; China doesn't want to give up Taiwan; and the US doesn't want to see any of its aircraft carriers sent to the bottom of the Taiwan Strait.

The Chinese may often wonder why this tiny island of 23 million people is so important to the United States. After all, Taiwan hasn't really been a democracy for all that long, and the US has much greater problems to deal with in trying to extract itself from Afghanistan and in restoring growth to its own economy.

But having now been to Taiwan and seen with my own eyes what it is all about, I have a better understanding. In the end, America cannot help but admire and support a budding democracy trying its best to resist a bullying, autocratic overlord. A little over 200 years ago, that was us.

A legitimate beef with China

A leader in this week's Economist, concerning the US Senate's passage of a bill intended to punish China for currency manipulation, warns that, however right the Senate may be about currency manipulation, passage of the bill would risk an unnecessary trade war.

The Economist goes on to say that America does have "legitimate beefs with China, but this bill is the wrong way to address them. It is legally flawed, economically dangerous and unnecessary." If passed, China would surely have a legitimate claim against the US through the WTO, and would almost certainly retaliate with its own trade-limiting measures.

While I understand the value of this measure as a political tactic for Senators who are part of the most hated US Congress in history, the fact is that there are better ways for America to get what it wants (not that Congress even cares).

While the WTO mechanisms designed to facilitate open trade are slow to work, China recognizes them as legitimate and has generally adhered to their judgments in the past. Although, as The Economist admits, currency manipulation is not addressed in WTO rules, America indeed has "legitimate beefs" with China that could be addressed under the WTO. Yet, for some reason, the US Congress chooses to focus on currency, and the Obama administration apparently chooses to look the other way when it comes to some of China's real WTO violations.

While I haven't cataloged all of China's violations, I know that there are several going on in the auto industry that no one seems to think are worth calling China on. For example, a couple of key measures in China's WTO accession agreement forbid China from conditioning investment in China on technology transfer and local content requirement. (This agreement dates back to 2001, by the way, so it's nothing new.)

As for the tech transfer part of the rules, China's ability to apply pressure to foreign automakers to transfer technology in exchange for permission to expand in the country has been well-documented. (A couple of example articles are here and here.)

The latest attempt by the Chinese to adhere to the letter of the law while blatantly violating its spirit includes holding off on investment approval until the foreign company "voluntarily" offers to contribute technology toward establishing a Chinese brand with its (state-owned) Chinese partner. Peugeot's CEO was quoted by the Financial Times as saying that, cooperating on building a Chinese brand is now "part of the deal."

And the automakers involved in this attempted extortion have no incentive to complain about it for fear of losing their access, all the while knowing that their competitors are all doing the same thing.

Okay, you may say, perhaps China's violations in this case would be too difficult to prove under the WTO's mechanisms. After all, the foreign automakers all appear to be "voluntarily" contributing technology in these cases, and anyway, none of them is complaining. Perhaps.

Then how about a more obvious violation of the rules? In this case, it involves the imposition of illegal local content requirements.

This actually surfaced a few weeks ago, and I commented about it on twitter, but only my friend @alexwoods5 seemed to think it was an issue worth being concerned about. The issue in question arose from a recent Wikileaks cable in which an employee of Ford in China revealed to US diplomatic personnel that Ford's operation in China is subject to a 40 percent local content requirement. This is the relevant section:

¶9. (SBU) All of Ford's parts suppliers must meet the Chinese Government's rules of minimum 40 percent local content by value, Chuang explained.

Does that not sound like a local content requirement? Could this have been a condition for Ford's recent investment in new factories in China?

I even emailed an acquaintance of mine at Ford, twice, seeking some sort of explanation or confirmation. The fact that he has yet even to respond with a "no comment" tells me that this may be worth investigating.

But is the Obama administration investigating it? If not, why not?

I know that the administration, or at least certain individuals in it, understand that the currency bill passed by the Senate would do great harm to both global trade and to America's relationship with China. But if they want to avoid such unpleasantness, why not at least make an effort to make China follow the agreements it has signed?

Who cares about IPR, what about innovation in China?

The Wall Street Journal reports on a brief debate that took place yesterday between US Ambassador to China, Gary Locke and an advisor to the People's Bank of China, Li Daokui. The exchange took place during a panel discussion at the World Economic Forum meeting currently taking place in Dalian, China.



The apparently civil discussion surrounded a disagreement as to the repercussions of China's difficulties in enforcing intellectual property rights (IPR) protections. In short, Locke expressed his view that lack of IPR enforcement would stifle Chinese innovation. Li, on the other hand, merely expressed his disagreement and noted that China's policy focus instead needed to be on supporting entrepreneurs and removing barriers to their success. (Notice how Li cleverly took Locke's cue and changed the topic from IPR to innovation?)

So who is right about innovation? Where should China focus its policy in order to better support innovation? Should it beef up IPR enforcement, or should it focus on removing barriers to the private sector? Which would give it the biggest bang for its policy buck? (Not that this is necessarily an either/or proposition -- China is big and rich enough now to do both -- but humor me on this.)

Some of my readers may be surprised to learn that I think Li Daokui was right. While Locke was certainly carrying out his duty as Ambassador by saying that China needs to improve IPR protection, the truth is that IPR protection has very little to do with innovation in a developing country like China. In fact, history tells us that, since the dawn of the Industrial Revolution, every subsequent country to jump on the development bandwagon has copied those who came before.

...every country that became economically great began by copying: the Germans copied the British; the Americans copied the British and the Germans, and the Japanese copied everybody.*

This is not to excuse the Chinese companies that blatantly copy foreign products and the government that often chooses to look the other way, but since Locke chose to introduce innovation into the discussion, the issue deserves a closer look.

My research on China's auto industry reveals that the most innovative among China's automakers are the private and independent automakers, not the massive state-owned enterprises (SOEs) with their foreign joint venture partners. While private players have yet to introduce any real breakthrough innovation, their progress in developing new energy vehicles and unique Chinese brands is ahead of the SOEs. The reason for this (and you'll have to take my word for it until my book comes out) is twofold.

First, leadership positions in SOEs are essentially political positions. The men who run these companies have their eyes on their next job, which will be a political appointment to run an association or a local government, or even to become a Vice Minister or Minister in the central government. In order to better assure themselves of a good position, they tend to be risk-averse in their decision making.

Second, because these guys have short-term investment horizons, "wasting" money on R&D is not high on their agendas. R&D spending only helps the next guy. It is much easier to rake in profits building and selling foreign branded cars. They simply lack the career incentives to take the kind of risks that result in significant innovation.

(Here is another story today about how "JV brands" have not resulted in the innovation that the central government had been hoping for. Why? Again, forcing foreign partners to hand over technology does not translate into innovation, especially when leadership incentives are not changed. I previously wrote about this "JV brands" or "sub brands" issue several months back.)

So while Li Daokui seemed to be changing the subject above, he was actually addressing Locke's point about innovation. And if China's auto industry is any kind of indication for China as a whole, the central government would do well to follow Li's advice and remove the barriers that continue to marginalize private business in China.

Of course, as an American, I would like to see the home team do well, so if China continues to insist on a preponderance of state control over all of its major industries, I believe that will ultimately be to the advantage of China's competitors. And they need every advantage they can get.

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* William Kingston, “An Agenda for Radical Intellectual Property Reform,” in International Public Goods and Transfer of Technology Under a Globalized Intellectual Property Regime, ed. Keith E. Maskus and Jerome H. Reichman (New York: Cambridge University Press, 2005), 658.

Outside world belatedly catches up to China reality

There's a big difference between reporting on reality in China and merely analyzing the news or talking to the government.

From the fall of 2008, when Warren Buffett first took his 10 percent stake in BYD, until very recently, practically every foreign news report or commentary about alternative energy vehicles had already declared China the ultimate winner. I long ago stopped trying to save every article I could find about China's “new energy vehicle” (NEV) industry because they began to appear formulaic.

Here's how it went. A foreign reporter, commentator or business leader would visit China, stopping first in Beijing to meet with government officials, then hop a plane to Shenzhen to test drive one of BYD's hybrids or EVs. Then he or she would return and write an article, based on no more than official government projections and a 10-minute test drive, proclaiming that the rest of the world was already far behind.

Of course, anyone who regularly follows news about China knows that those early stories – which persisted throughout 2009 and 2010, and even into 2011 – were way too optimistic. (A couple of stories on this very topic that came up today are here and here.) The once-vaunted BYD, having suffered a growth rate only half that of China's auto industry as a whole in 2010, and having seen its profits drop a further 89 percent in the first half of this year, is no longer the darling of innovation it once appeared to be. (Recall that BusinessWeek ranked BYD the 8th most innovative company IN THE WORLD in 2010!)

So how did those early visitors to China get their assessments so wrong? They didn't talk to the right people. So many foreign business leaders head off to China, meet with government leaders and return assuming they know everything they need to know. After all, China's government is in charge. They get what they want, right?

Well, anyone willing to swallow Chinese government policy back in 2009 would still be expecting to see 500,000 NEVs plying China's roads by the end of this year. While I don't have a final count of the number sold so far, I do know that in 2010, only about 1,000 of these cars were put into service in all of China. And the news I've seen so far this year, though not comprehensive, seems to suggest that maybe even fewer of these NEVs have been sold in 2011.

Of course, I cannot really point my finger at anyone else because, early on, I was just as guilty. My early blog posts about BYD should have been more skeptical, less optimistic. I won't be too hard on myself though, because, by the spring of 2009, I had turned somewhat pessimistic, asking "Will China Lead the World in New Energy Vehicles?" (May 2009). Or maybe “realistic” is a better word.

What led to my newfound skepticism? I went to China. But I didn't talk to central government officials (though I tried); I talked to analysts, auto company insiders, scholars, and business people.

My point here is not to say that I “get China” and no one else does. What I am trying to say is that, at one time I did get at least one aspect of China, and only because I went there and managed to talk to some of the right people. In all fairness there were also a few foreign journalists in China who also got it at the time, though their voices were in the minority.

The difference for anyone who truly reaches a level of understanding about any aspect of China is not only about being on the ground there, but also about talking to the right people. The May 2009 post I linked to above was written from my hotel room in Shanghai after I had only been in-country for about three weeks. But what a difference those three weeks made in how I viewed China's NEV prospects.

As I now sit here at my desk in Los Angeles, I feel, unfortunately, about as disconnected from China as I have been in quite awhile. Not having been there to talk to people (I've been busy with a little writing project for the past year-plus), all I can do is read the news coming out of China, try to distill fact from fiction, and apply theories I have developed based on previous experience.

That said, one can learn much about China in general by watching and reading from a distance. In this way we can hone theories that help us to understand what we see. Then we can test those theories with later events or situations to determine whether those theories were correct.

Unfortunately for investors, economists and business people, the operative theory regarding China's NEV industry in 2008-2010 seems to have been twofold: First, China's government always gets what it wants. And second, if Warren Buffett is investing there, it must be a sure thing.

In this case, I think we can safely toss that theory aside – or at least be careful in how we apply it in the future. Theories are nice, and they will do in a pinch, but there's really no substitute for doing the footwork to truly understand what is going on in the world.

We China-watchers need to return periodically and fill our buckets with new data points to chew on.

American Wheels, Chinese Roads: a review

For several months I have been eagerly awaiting the arrival of Michael J. Dunne's new book, American Wheels, Chinese Roads: The Story of General Motors in China (Singapore: John Wiley & Sons Asia, 2011).


If you have read any news stories covering China's auto industry over the past decade, you have almost certainly read quotes from Mike Dunne. Until recently he was in charge of J.D. Power's China unit, and now he runs his own consulting company.

There are few people more qualified than Mike Dunne to write about China's auto industry. He grew up in Detroit, worked at GM, and earned his MBA from the University of Michigan. He has also spent over two decades of his life living and working in China.

American Wheels, Chinese Roads is a more-or-less chronological telling of the experience of General Motors in China, but at appropriate points, Dunne interjects relevant stories about other auto companies and their experiences in China. And it is a pretty quick read because the story is so entertainingly told.

The stories are all fascinating because many reveal lessons that GM learned along the way and often contain fly-on-the-wall details about negotiations between Chinese and foreign automakers. Dunne makes these stories even more interesting (and demonstrates his China credentials) by weaving in little Chinese language lessons and references to Chinese philosophers and historical figures. He doesn't just lay the lessons on us; he often delves deeper into why things are the way they are in China.

At a few points, GM is portrayed almost as a naive victim, caught off guard by the machinations of the government or GM's competitors. For example, when GM inked its deal with Shanghai Auto (SAIC), it was promised a monopoly in the luxury vehicle segment only to be surprised a few months later that Shanghai Auto's other partner, Volkswagen was being allowed to introduce a competing vehicle.

Dunne also retells the story about how Chery Auto managed to beat GM to market with the QQ, a copy of the Chevrolet Spark, adding new details that I had not seen elsewhere.

GM's curious sale of one percent of its joint venture to Shanghai Auto in 2009 is also covered here, though little is said about the possible motivation of SAIC. (But you will be able to find SAIC's side of the story in my forthcoming book on China's auto industry.)

In the penultimate chapter, Dunne sums up the experiences, not only of GM, but most foreign companies attempting to succeed in China:

While placing their bets, companies must never forget that to be dealt a hand in the game of electric cars -- or almost any business in China -- you will need to get approval for a license.

And get a partner.

Once those are secured, you will begin to compete with both the house and the player. The ones making the rules are also playing the game -- and they're determined to triumph.

This nicely sums up much of my own research on China's auto industry. Getting into China is hard, and once there, you will only be there as long as the Chinese find you useful.

In terms of the details, I was very pleased to find that Dunne's take on China's auto industry largely agrees with my own -- not that it has to, but having spent several years researching this industry in which Dunne is an expert, I am happy to note that my own research was not off-base. This is not always the case when two writers tackle the same topic in relation to China: it often depends on which part of the elephant one is touching.

As enjoyable as this book was to read (it is truly a page-turner!), as a researcher, I often wished to see footnotes to support certain quotes, figures or other claims. For some reason, the non-academic world has an aversion to footnotes. From the point-of-view of a researcher, footnotes make a particular work more attractive as a documentary source, and ensures that the book is cited more frequently. More citations will very likely translate into more sales. (And if you're the kind of reader who hates footnotes, you may also be happy that the book comes in a Kindle edition.)

My sense in this case is that many of the quotes come from Dunne's first-hand experience, although I would not have minded his saying so in the text. There seems to be a trend toward increasing acceptable use of the first person in non-fiction nowadays, a trend that I fully support: if you did the work, conducted the interview, etc., I think you should feel free to say so.

But this minimal criticism only reflects my personal preference, and in no way does it detract from this book as both an entertaining work of non-fiction and a source of wise advice on the pleasures and pitfalls of doing business in China.

In the conclusion, Dunne leaves no doubt as to where he stands in his own assessment of the business environment for foreigners in China. His parting shot takes the form of a fictitious memo from a foreign auto executive in China to the US Auto Task Force. His final recommendations aren't delivered in anger; they are a matter-of-fact assessment of a playing field on which foreign businesses have been forced to face down the entire Chinese government all on their own for far too long.

US budget issues predicted in the 1970s

This post contains no business advice and is only tangentially related to China. You have been warned. :-)

Having recently read Daniel Bell's The Cultural Contradictions of Capitalism, I am reminded of how, back in the 1970s, Bell predicted the budget issues we are now enduring in the United States.

The fundamental political fact in the second half of the twentieth century has been the extension of state-directed economies. These developed first because of the need to rescue the system from depression, later because of the demands of a war economy and the enlargement of military commitments, and finally because of the strategic role of fiscal policy in affecting levels of spending and patterns of investment...

The new “class struggles” of the post-industrial society are less a matter of conflict between management and worker in the economic enterprise than the pull and tug of various organized segments to influence the state budget. Where state expenditure approximates 40 percent of Gross National Product, as it almost does in the United States … the chief political issues become the allocation of monies and the incidence of taxation.

… it is also likely that in the United States a state-directed economy and a state-managed society will please no one... Radicals are becoming increasingly suspicious of government … even though their first reaction to any issue is to call for more “government,” … And the state management that will emerge will be a cumbersome, bureaucratic monstrosity, wrenched in all directions by the clamor for subsidies and entitlements by various corporate and communal groups, yet gorging itself on increased governmental appropriations to become a Leviathan in its own right.

Oh, and did I mention that Bell was an admitted "socialist"? (If you watch Fox News, please don't let that word put you off just yet.)

By way of background, the most significant "contradiction of capitalism" that Bell identified was one between asceticism and acquisitiveness. The Protestant work ethic that Max Weber credited for turning work into a “calling” for Americans and implanting within us the idea that the work itself and the associated accumulation of capital were honorable pursuits, became (sometime during the 20th century) conflicted with the rise of consumer culture encouraged by the introduction of installment credit.

The resulting conflict has shifted the focus of American society 180 degrees from a focus on production to a focus on consumption. Whereas, according to Weber, Americans were all previously motivated by hard work and savings as the ultimate service to God and country, according to Bell, not only have God and country been supplanted by the individual, but we now all measure ourselves by how much we are able to consume.

In other words, employers demand of their workers a traditionally puritan level of commitment to work while urging their customers toward a hedonistic, anything goes, make-yourself-happy-and-screw-everyone-else lifestyle. The obvious problem here is that the workers and the consumers are the same group of people.

But I digress...

Back to Bell's quote above, if Bell was right, then we haven't even begun to see the worst of impending budget fights. Even if the two sides in Washington are able to reach a last minute deal this time, nothing will be done to solve the fundamental issues that have placed the budget front and center of American politics.

Think about it. Seemingly all discussions in Washington now revolve around spending and taxation. Rarely does the debate have anything to do with what sort of society we want to be.

I said above that this post would have little to do with China, but having written this far, I cannot help but wonder whether China's form of state capitalism might not also lead to similar contradictions.

Again quoting Bell:

In a modern [i.e. capitalist] society, the engine of appetite is the increased standard of living and the diversity of products that make up so much of the splendid color of life. But it is also, in its emphasis on display, a reckless squandering of resources... [If you're a China watcher, and this doesn't sound familiar, perhaps you haven't been to China in awhile.]

Where resources are prodigal, or individuals accept a high degree of inequality as normal or just, this consumption can be accommodated. But when everyone in society joins in the demand for more, expecting this as a matter of right, and resources are limited, ... then one begins to see the basis for the tension between the demands in the polity and the limitations set by the economy.

Bell says this results in five elements that are "structurally transforming the old market system":

1. institutionalized expectations of economic growth and a rising standard of living.
2. the incompatibility of various wants and diverse values
3. enormous spillover effects from economic growth (e.g. environmental effects)
4. a worldwide inflation -- "the largely inescapable consequence of a commitment to economic growth and full employment"
5. crucial decisions about the economy are no longer left to the market, but become political questions.
   

When Bell wrote all of this in the mid-1970s, he wasn't really thinking of China (how could anyone have predicted what China would become?), but his descriptions of problems that would soon afflict the US now also seem to apply to China.

While conventional wisdom tells us that China's leaders are probably patting themselves on the back for rejecting democracy and its besetting partisan difficulties, does Bell's warning indicate that China may also be running headlong into a similar set of problems?

Business Insider Quietly Changes its Headline

In yesterday's post I noted that a story on the increasingly popular Business Insider website misread its source, resulting in a headline and content that were patently false. Several commenters to the original BI story also pointed out that the author had made false claims.

I followed the link in yesterday's post to see if there had been any changes to the story to find that the headline has been changed.

Yesterday's headline: These Fake Chinese Microchips Were Made To Disarm U.S. Missiles

Today's headline: The Navy Bought Fake Chinese Microchips That Could Have Disarmed U.S. Missiles

While the new headline is somewhat less inflammatory, it still doesn't address the false allegation here, which is that a Chinese entity sold chips to the US that had the capability of being used to disarm US missiles.

Having read both the Wired story and the Washington Post story, I can still find no suggestion that this was the case. By all indications, these were merely "fake" chips -- fake in the sense that they looked like real chips and performed like real chips -- in the same way that a fake Gucci bag both looks and performs like a real one.

In no way do I want to minimize the potential for serious damage that a fake chip could cause to an airplane. I get the fact the potential for damage is much greater than that of a fake handbag.

But there is a HUGE difference in the political implications between a fake chip and a chip that has been deliberately designed to cause damage. HUGE. And if Business Insider doesn't get that, then they are in the wrong business.

Of course the chips "could have" been designed with a back-door, but as long as all possibilities are on the table, let's go ahead and acknowledge that China "could have" nuked Los Angeles yesterday. I mean, they do possess that capability, right?

I looked for some sort of mea culpa, but didn't find one. As a commenter to my post from yesterday seems to imply, Business Insider's inflammatory headline has probably already generated enough page views anyway.

If, for some reason, Business Insider should start to lose viewers in the West, I'm sure Xinhua would welcome some of their editorial expertise. ;-)

"Hostile Foreign Forces" Making Up Stuff About China

Whenever China encounters difficulties or problems, its state-owned media and foreign ministry are often quick to blame "hostile foreign forces" which include foreign (i.e. non-Chinese) media organizations. These accusations are often preposterous, but unfortunately, they are sometimes based in fact.

An article posted today on Business Insider serves as an unfortunate illustration. The article, "These Fake Chinese Microchips Were Made To Disarm U.S. Missiles," by Robert Johnson levels some startling charges:

Last year, the U.S. Navy bought 59,000 microchips for use in everything from missiles to transponders that turned out to be counterfeits from China.

Wired reports the chips weren't only low-quality fakes, they had been made with a "back-door" and could have been remotely shut down at any time.

What??!! This is a major international incident! Why is it not all over the news?

Following the link to the Wired report, we find out why: it simply isn't true.

The chips turned out to be counterfeits from China, but it could have been even worse. Instead of crappy Chinese fakes being put into Navy weapons systems, the chips could have been hacked, able to shut off a missile in the event of war...

...but they weren't, and a further link in the Wired report to a Washington Post story fills us in on the actual facts as reported by an actual journalist (not that all actual journalists are above fabrication).

My point is that we need to be better than this. If a Chinese company somehow conspired to get fake chips with backdoors into US hardware, then, by all means, let's nail them to the wall. But Business Insider's Robert Johnson has either read the Wired article so quickly that he failed to fully understand it, or he has maliciously fabricated a false story -- and neither reflects very well on Business Insider.

And it just adds to the pile of evidence that the "hostile foreign forces" really do exist.

China's corrupt, opaque system will continue to produce enough negative stories on its own. It isn't necessary to make up stuff like this.

_______________
EDIT: Note that since I posted the above, Business Insider has since changed its headline slightly, which prompted me to write this subsequent post.

photos

Toyota logo (right), Geely Merrie logo (left)









Roewe 750 and MG7





















Mercedes C-Class (top), Geely Merrie (Meiri) (bottom)



















Jeep Cherokee (ca. 1997 top), Beijing Auto "Qishi" (bottom)
























Jinbei "Mianbao che"















Toyota Corolla (top), BYD F3 (bottom)


























Great Wall Test Track, Baoding, China

Saab-Hawtai

Saab-Hawtai

Interesting things happening with the failed purchase of Saab by Hawtai. I wish I had more time to comment on this, but I am in the homestretch to finish my dissertation and get it filed -- possibly as early as next week. I will say, however, that I find it interesting that the two sides are starting to change their stories.

My guess, based on what little reading I've had time for, is that Beijing wants Saab to go to one of the larger Chinese automakers. The last thing it wants to do is strengthen a tiny, private automaker like Hawtai which only produced about 80,000 vehicles last year. And the reason China's other automakers haven't stepped up to bail out Saab yet is that they are counting on Saab's assets being cheaper after Saab has declared bankruptcy. Smart move.

The Chinese media are all suddenly beginning to say (almost as if directed by someone) that Chinese automakers no longer need foreign help. Which, I'm sorry, is total BS. If Chinese automakers had the necessary engineering skills to build great cars, they would be flooding the American market with them as we speak.

Finally, some good news for BYD

Last October I wrote about a situation in which BYD, the private automaker from Shenzhen, was punished for attempting to build a factory on farmland near Xi'an.

In short, BYD was fined about $435K and had seven buildings, on which it had already begun construction, confiscated and ordered destroyed. In addition 14 local officials in Shaanxi province were also punished for violating rules forbidding the use of arable land for non-farming purposes. Ouch. And this came in a tough year for BYD whose sales only grew 16 percent in 2010 (compared to China's auto industry as a whole which enjoyed 32 percent growth).

The story surfaced a few days ago that BYD was preparing to restart construction in Xi'an. According to an earlier story in the Economic Observer, the land has been "legalized" (合法化) and rezoned as industrial land. BYD was allowed to bid for the land in a public auction, and -- surprise! -- BYD won the auction. (There was no word on whether anyone else bid for the land.)

Even though BYD didn't get all of the land it had secured before, it still got most of the land, and, most conveniently, it got the part of the land on which its unfinished construction already stood. Back in October, the announcement from the Ministry of Land and Resources said BYD's buildings would have to be destroyed, but, fortunately for BYD, no one had got around to destroying them yet.

This strikes me as quite a miraculous turnabout for BYD. The problem that led to BYD's punishment was (and is) that China, despite being a huge country, has precious little of the arable land it needs to feed 1.3 billion people. The central government has recently become quite serious about preserving arable land.

But not that serious apparently.

In the months following BYD's punishment last October, Local officials in Xi'an had begun to complain that they had been deprived of a major source of local income -- sales of land use rights. The Economic Observer quoted a local official as saying that Shaanxi's annual demand for industrial land is running at about 400,000 mu (67,000 acres) per year, but they are only able to supply about 150,000 mu.

I was initially happy to see the central government finally taking a stand last fall by supporting their own laws forbidding illegal use of arable land. For once, it wasn't just about the money. At the time, I took this as a positive sign that rule-of-law was actually starting to mean something in China.

It's amazing to me how a scarce resource such as arable land could have been so quickly and easily "rezoned" as industrial. Apparently it really was about the money.

Creating 'Chinese' brands now 'part of the deal' for foreign automakers

Last December I wrote about a trend among Chinese-foreign automotive joint ventures in which the foreign partner gives technology to the JV to sell under a Chinese brand. Some of the English language China auto blogs refer to these as "sub-brands."

For example, Honda contributed the design of an outdated City vehicle it no longer makes to its JV with Guangzhou Auto. The JV now sells it under the Chinese brand Linian.

At the time I noticed this trend among several automakers (Guangzhou Honda, Dongfeng Nissan, Shanghai-GM), my assumption was that this was an attempt on the part of the Chinese automakers to wean Chinese consumers away from foreign brands. Chinese consumers still overwhelmingly prefer foreign brands (if they can afford them), because they perceive them to have higher quality.

Now several other foreign automakers including Volkswagen and PSA Peugeot-Citroen are discussing similar arrangements with their Chinese partners. PSA Peugeot-Citroen's CEO told the Financial Times that helping their partner to develop a local brand is now "part of the deal".

Last December I speculated that this may have been under central government coordination, but I had no evidence of that. Today, evidence seems to have surfaced in this report from the Financial Times.

The story quotes Mike Dunne, formerly of JD Power in China, who now has his own consulting company:

Nothing is written down, but when automakers go to apply for capacity expansion, in their application it’s clear that they should have a plan for an indigenous brand with jointly owned product rights and some provision for new energy vehicles. Foreigners want more capacity; China is saying: ‘We want more own brands’.

Back in 2001, when China joined the WTO, they gave up the right to demand technology transfer as a condition for approval of foreign investment. Of course, this new rule did nothing to change China's appetite for foreign technology.

The new demand, rather than for "technology transfer", appears to be: if you want to expand capacity, then X% needs to be devoted to Chinese-branded cars.

The foreign automakers now have a choice. They can pour precious R&D money into joint development of cars that compete directly with their own, or they can just hand over technology they already have.

The technology the foreigners are now handing over may be slightly outdated, so the foreigners aren't being forced to hand over their latest and greatest innovations. But again, it seems to me that these foreign-designed, Chinese-branded cars that the central government is now forcing the JVs to sell will fill the perceived quality gap between Chinese- and foreign-branded cars.

China's central government fully intends that its largest state-owned automakers will be global contenders, and they are patiently finding ways to make that happen. The WTO will not stand in the way. Wherever there's a rule, there's a way around it.

How fragmented is China's auto industry?

For anyone wondering where I've been for the past several months, I've been right here at my desk. But instead of posting to this blog, I've been in a push to complete a full first draft of my dissertation by the end of March -- which is beginning to look like a real possibility.

For now, here's a quick post of some numbers I've been looking at for the past few days on market shares in China's auto industry.

Probably the most consistent component of China's auto policy since the mid-80s has been the insistence of the central government on consolidation in the industry. Just looking at the raw numbers, I think most people would agree that this demand has been completely justified.

In 1978, the year that Deng Xiaoping launched the first experimental market reforms in China, there were 55 auto assemblers. The number peaked at 124 in the mid-90s, and by 2008 (the latest numbers available) there were still 117 -- clearly, way too many.

But just how fragmented is China's auto industry? Here is a quick comparison with the US.

This chart compares cumulative 2010 market shares for the top five auto companies in the US and China.








If China were to take the US as its example, then it would seem to have already achieved a fair amount of consolidation. China’s largest auto group has a slightly larger share of its market than does the largest automaker in the U.S., and the top five in both markets are practically even.

Of course, we already know that the US market is somewhat less concentrated than it used to be. In 1980, for example, the Detroit Three held 76 percent of the US market. But I think few people would argue that less concentration in the US market has not been good for consumers.

So while it would appear that China is starting to see some solid growth out of the players at the top of its auto industry, the problem lies with all of those tiny companies at the bottom that, for some reason, refuse to go away.

Who are these small players? Quite a few are small, locally-owned automakers that lack any kind of scale to be profitable. In any given year, they probably break even on a cash flow basis, which means that the local government is absorbing their cost of capital. If exposed to true market competition, these small firms would quickly disappear.

So why haven't they? Local governments don't want them to. They employ anywhere from a few dozen to maybe even a few hundred local people, and local governments are not inclined to create any more of an unemployment problem than they have to.

Of course, the central government, through the NDRC or MIIT, could force these local enterprises to close, but why would they? The central government is no more interested in putting people out of work than are the local governments.

So if we simply accept that some of these small players are part of a welfare system that keeps people gainfully employed, then China's leaders should at least be satisfied that, at the top of its auto industry, it appears to have the makings of an increasingly strong and competitive industry. Right?

I don't think so, and this next chart reveals why.

Here we have the top five companies in both the US and China along with their respective market shares.









What I notice about this chart is that each of the companies on the US side also corresponds with a brand, but each of the companies on the Chinese side is just a big old state-owned enterprise that assembles cars for foreign companies.

SAIC makes most of its money selling VW and GM cars. Dongfeng sells Nissan and Citroen. FAW sells Toyota and VW. Chang'an sells Ford, Mazda and Suzuki. BAIC sells Hyundai and Mercedes.

Yes, each of these companies also sells some cars under its own brand, but the numbers are comparatively small. Overall, only 30.9 percent of sedans sold in China in 2010 were of local brands -- up only slightly from 30 percent in 2009.

And therein lies the problem. China's central government wants its biggest SOEs to get bigger so that they can compete with the foreign multinationals. For now, they would just like to dominate in their own market, but eventually, they want to compete in overseas markets as well.

The problem is that, while these SOEs are indeed developing their own brands, it's just so easy to sit back and rake in profits while the foreigners contribute all of the intellectual property.

Designing your own stuff is hard.

A little more clarity on Geely (a little less on Volvo?)

More arcane corporate governance stuff...

In my previous post, I noted that Geely's 2008 and 2009 annual reports mentioned an unnamed "associate" of Li Shufu as co-owners of the entity that has ultimate control over the sprawling Geely empire.

In the interest of ensuring my readers (all three of you) have the most up-to-date information that I have, and in the interest of the pursuit of truth and transparency, I think a new post is in order.

Fortunately for the English speaking world, Geely is listed in Hong Kong, which means that, not only is the company required to report significant events to its shareholders, but it is also required to do so in English. (Call me lazy, but plowing through a 150-page annual report in Chinese is not my idea of fun--not to mention the fact that mainland reporting standards still don't measure up to those in HK.)

Here is what I have learned today. I can now say for certain that Li Shufu has complete (legal) control over the Geely listed company. This document (pdf) that I found on the HKSE website just happens to mention that Li Shufu owns 90 percent of Zhejiang Geely Holding Group, Ltd. (ZGHGL), which means the "associate" (in the yellow box) can own no more than 10 percent. (See abbreviated corporate structure below.)

What the document also spells out is exactly which entity now owns Volvo. As you can see in the structure below, I have added a couple of boxes at the bottom left side. The green box is "controlled" by ZGHGL (which we now know is 90% owned by Li Shufu). The orange box is Volvo, which is clearly owned and controlled, not by the listed Geely Auto Holdings (the purple box), but by Li Shufu's unlisted ZGHGL.

That explains why Li Shufu has been quoted as saying, "Volvo is Volvo, and Geely is Geely", meaning that these two companies are entirely separate entities. The only thing they have in common is control by Li Shufu.

This means a couple of things.

First, Li Shufu almost certainly had to rely on bank loans in order to pull off the Volvo purchase. Since the cash on the HK-listed Geely Auto Holdings' balance sheet belongs, not only to Li Shufu, but also to the company's public shareholders, Li Shufu could not have used Geely's cash to fund even part the Volvo purchase. Whatever cash was put into the deal would have had to come from any of the entities on the Li Shufu side of the chart. (Yes, it's possible Li could have borrowed money from Geely for the Volvo purchase.)

And while it's possible those entities have other business operations of which we aren't aware, the likelihood that these apparent shell companies were sitting on the necessary cash to fund the deal is pretty slim. Of $1.3billion in cash given to Ford in the Volvo purchase (Ford also got a note for $200 million), about $588 million came from Daqing and Jiading local governments, the remaining $712 million would have had to come from Li Shufu-related entities. At least part of that must have come from loans. (Early indications were that several major state-owned banks were lining up to help with the Volvo purchase, but this has not been verified since the purchase took place last August.)

Second, because Volvo is now 100 percent owned by an unlisted entity, we will no longer have full transparency into the company's operations.