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?
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.
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.
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.
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":
- institutionalized expectations of economic growth and a rising standard of living.
- the incompatibility of various wants and diverse values
- enormous spillover effects from economic growth (e.g. environmental effects)
- a worldwide inflation -- "the largely inescapable consequence of a commitment to economic growth and full employment"
- 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?
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. ;-)
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.
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EDIT: Note that since I posted the above, Business Insider has since changed its headline slightly, which prompted me to write this subsequent post.
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