Go East, Young Man

The Real “Great Leap Forward”

Plus, a special “Go East” bonus section.

One criticism of my “Where’s My $58 Million, Madame Wu?” column, in which I described the adventures of a 1990s China investment fund, was that, given the speed at which China is changing, the 1990s were equivalent to the Dark Ages. So let’s get up to date.

Foreign business in China follows two distinct strategies: export and domestic. The export strategy is to take advantage of China’s low-cost manufacturing capabilities by making products to sell elsewhere in the world. The domestic strategy, meanwhile, is to sell products and services to the 1.3 billion Chinese consumers (or rather, to the small minority who make more than a couple of dollars a day).

According to China, Inc., a (great) new book by Ted Fishman, China now draws more foreign investment capital than any other country ($53 billion in 2003). The half-trillion foreign dollars invested in China since 1979 have built an estimated one-third of the country’s current production capacity. A large chunk of this money, interestingly, has come from Chinese expatriates, some of whom fled the country during the Communist takeover.

The domestic strategy, selling to Chinese consumers, is challenging but often successful. Most of the country is still locked in unfathomable poverty—25 years of economic progress in rural Xiaogang, Fishman reports, have increased annual per capita income from $2.50 to $313—but China’s population is so huge that even a fraction of it represents an enormous market. For example, according to the Harvard Business Review, China is now adding 4 million to 6 million new cell phone subscribers per month. This statistic is mind-boggling. It means that, every year, China adds a new cell phone market about the size of Germany’s—and Germany is the third-largest cell phone market in the world. (No wonder handset manufacturers like Motorola are so jazzed about China.) Other products that foreign companies are selling include cars, soap, sneakers, shampoo, watches, soda, beer, noodles, hot water heaters, televisions, clothes, VCRs, film, coffee, courier services, cameras, and motorcycles.

Still, the most common foreign-business strategy in China is export. China’s manufacturing costs are so low that factories can undercut not only operations in the United States and Europe, but previous low-cost export platforms like the Philippines and Mexico. Because so many companies have now pitched camp in China, today’s manufacturers usually have two choices: follow or quit. As China’s economy has developed, moreover, its manufacturing capabilities have become increasingly sophisticated, allowing factories to climb the complexity ladder. In 1990, according to the Harvard Business Review, China led the world in the production only of textiles and televisions. By 2002, this dominance had extended to refrigerators, PCs, motorbikes, cigarette lighters, and cell phone handsets. What’s more, so many of China’s impoverished farmers and unemployed state workers need jobs that China’s production costs are likely to stay low for decades. Ted Fishman says that between 90 million and 300 million Chinese farmers have migrated to cities in recent years—a labor pool that, even at the midpoint of that range, exceeds the total workforce of the United States.Fishman also observes that, between 1998 and 2001, China’s state-run companies fired 21 million people, more workers than are employed by the entire U.S. manufacturing industry.

Of course, it is not just foreigners who have noticed China’s manufacturing supremacy. Chinese companies are also exporting hundreds of billions of dollars’ worth of products each year (and they’re selling more than cigarette lighters and fireworks). For example, according to the Harvard Business Review, Pearl River Piano now owns more than 10 percent of the U.S. piano market; CIMC makes and sells most of the world’s shipping containers; Galanz supplies 40 percent of Europe’s microwave ovens; and Haier not only clubs Whirlpool, Siemens, Electrolux, and Matsushita in China’s domestic home-appliance market but is now invading the low end of the U.S. market as well (click here to buy a Haier countertop dishwasher). Furthermore, despite the soothing myth murmured by U.S. digerati (“We design it, they make it”), China’s high-tech industry is developing fast. By 2002 China’s digital switch and router leader, Huawei, owned 3 percent of the international router market—a beachhead gained by introducing products that cost 40 percent less than, say, Cisco’s.

In some areas, China’s advantages extend to the top of the food chain. One industry in which China could conceivably develop a sustainable advantage over foreign competitors, for example, is biotech. Here, U.S. regulatory policies and religion often act as a straitjacket: Now that President Bush has decreed that destroying embryos for stem-cell research is immoral, for example, federal stem-cell funding has been curtailed. China, meanwhile, has recognized that stem-cell research is an area in which the country could take the global lead. Thus, China has made it a national priority.

So, if the 1990s were the Dark Ages for doing business with China, this is a snapshot of what the opportunity looks like today. Based in part on this snapshot, I am ready to offer a preliminary answer to one of the two questions I posed at the outset of this series: Is the China business opportunity real enough that the next generation of gold-seekers should “go East”? Provided one construes “go East” to mean “learn Mandarin, develop guanxi, and be prepared to weather multiple economic and political storms over a multi-decade career,” the preliminary answer is “Yes.” I say “preliminary” because the next books on my reading list have titles like The Coming China Collapse.

Now for today’s special “Go East, Young Man” bonus section!

The Pursuit of Truth Department—in which I revisit issues, errors, and misconceptions introduced in previous Go East columns, with the goal of eventually getting things right. Please continue to send feedback, corrections, and suggestions to chinagoldrush@yahoo.com.

Several readers pointed out that the entity that I referred to here as the Ministry of Foreign Trade and Economic Cooperation has, understandably (thankfully), been renamed the Ministry of Commerce.

In the column about foreign direct investment, I suggested that 15 years of capital inflows had probably reduced potential returns for today’s China investors. I should have said 25 years of inflows, not 15. China was opened to limited forms of foreign investment in 1979.

In response to one reader’s prediction that my next China clichés would include hilarious language gaffes resulting from words like “horse” and “fuck” being only a tone apart, several readers reported that “horse” and “fuck” are NOT a tone apart. One said:

The person who told you this was either ignorant or an idiot. horse = ma3
fuck = cao4There are two reasons for this confusion: 1. The phrase “ta1 ma1 da4.” is usually translated as “damn it” or “fuck.” The “ma1” in this phrase is actually “mother.” There are actually numerous cuss words in Chinese that involve family members, but my favorite is “Ni3 de4 ye2.” which is just “your grandfather.” It’s harsh enough to let the person know you’re mad, but not so harsh that they will feel the need to bash your brains in. 2)There is also the word “ma4” which means to scold or swear, as in “He scolded me.” (ta1 ma4 wo3 le.)

I suggested here that the “ticking time bomb” in China’s economy was leverage created by bad loans from China’s crappy state-run banks to China’s crappy state-run companies and that this leverage would one day lead to a massive economic bust. I should have said it would probably lead to a bust, because nothing in finance or economics is certain—ever. I should also have introduced the concept of “overcapacity.” Leverage by itself is usually harmless. It is leverage that leads to overcapacity (too many buildings, factories, Internet portals, etc.) that sets the table for disaster.

After insinuating here that the American investment firm the Carlyle Group might know something about guanxi—a Chinese concept encompassing the connections, relationships, and indebtedness helpful for facilitating transactions—I received a note from the Carlyle Group. The spokesman suggested that if anyone should know that perception is not always reality it should be me, and that, in the case of TCG, I didn’t know what I was talking about (no argument here). In the ensuing polite conversation, I learned that the usual smear against TCG is that the cozy relationship between Donald Rumsfeld and former TCG chairman Frank Carlucci results in Defense Department contracts being steered to TCG portfolio companies (I didn’t know this. All I knew was that the firm had a reputation for hiring deeply connected people. I wasn’t surprised or offended by this—it seemed like smart business to me). As the firm’s spokesman pointed out, the existence of a Rumsfeld-Carlucci relationship doesn’t mean that Defense Department-TCG business, if any, is conducted improperly. Such relationships do grease wheels, of course (how could they not? we’re humans, not robots), and TCG et al., are sharp, not sleazy, to recognize this.

This exchange, perhaps, illustrates the distinction between American “connections” and Chinese guanxi. In both countries, personal relationships often make the difference between winning or losing business (or even being considered for it). In America, however, it is considered distasteful or even illegal for a bureaucrat to steer business to his or her buddies (business people, of course, do it all the time). In China, meanwhile, personal relationships and indebtedness seem to take precedence over other considerations, and, more important, this seems to be viewed as perfectly acceptable. One reader provided the following illustration:

Guanxi runs much, much deeper than a corporate “I’ll scratch your back, you scratch mine” arrangement. Say, for example, you need a plane ticket to Shenzhen—fast. You dash up to the counter and ask to buy a ticket. “I’m sorry,” the ticket guy says, “the plane is full.” Glumly, you slide over to contemplate your options, when someone walks up and buys a ticket on the very flight you wanted. What’s going on? Well, it turns out the guy who just aced you out of a ticket is a close friend of the counter guy, and he was saving the seat for his buddy. See, you don’t have guanxi to the guy behind the counter; he doesn’t care if you get on the flight or not. It doesn’t matter if you offered him twice the seat price (because he’d lose face to his friend). You’re missing your meeting in Shenzhen …

Knowing that the above situation would make me apoplectic—and figuring, therefore, that there was, in fact, a major cultural difference—I asked the writer whether the jilted Chinese in the waiting room would be cool with this behavior. “Oh, they’d be pissed,” he said, “but they’d understand it. … Life in China cannot be made completely fair because this kind of favoritism isn’t really considered bad. It’s not corruption. It’s guanxi. It’s the social lubricant. It’s Confucian, in a sense. … This, by the way, is the reason why Communist Party campaigns to stamp out corruption always fail. What you see as ‘corruption’ is guanxi.”

Which brings us to a final area of reader feedback: corruption. Several readers complimented me for seeing parallels between Chinese and American business culture rather than differences (face-saving, guanxi, etc.). One topic about which readers usually disagreed with the parallels, however, was corruption. Donating to politicians and doing mutual-back-scratching business deals, readers said, was fundamentally different than paying bribes. In one sense, I agree: Political donations are not usually (explicitly) tied to tit-for-tat service, and mutual back-scratching in business is par for the course. Cash bribes, on the other hand, are secret and, in some cases, extortionist—and, in this country, they are viewed as sleazy or criminal. What I wonder, though, is whether this is again largely a question of cultural perspective (I know which system I’d rather do business in, but maybe that’s because I was born and raised in it). In America, political donations, back-scratching, connections, taxes, municipal fees, etc., are often seen as a cost of doing business. In China, it seems, the same can be said about actual tit-for-tat bribes (which doesn’t mean people are happy about them—who’s happy about paying taxes?). This will be an interesting topic to explore when I finally get to China.