Q&A With Author of “The People’s Republic of Chemicals”

PRC cover

Nothing threatens the stability of China’s economic miracle more than the hazardous levels of pollution generated by rapid development. The rise of the private automobile, unregulated toxic factories, and the widespread use of coal-burning as an energy source have all contributed to environmental degradation across China’s cities. While in the past, these issues were swept under the rug in favor of economic growth at all costs, the rise in living standards means that China’s leadership can no longer ignore the concerns of the people they serve.

China is now at a crucial turning point where economic goals must be balanced with considerations for the environment going forward. This is not an easy problem to tackle and the solution will require a global effort.

The new book The People’s Republic of Chemicals serves as an excellent starting point in understanding how China’s pollution problem got so out of hand in the first place and what can be done to stop it (or at least slow it down). The book’s co-authors, William Kelly and Chip Jacobs, are appropriate storytellers having together written the 2008 book Smogtown about the rise and fall of pollution in mid-century Los Angeles.

William took the time to answer some questions for us about their new book:

Adam Mayer (AM): As you observe in your previous book, Smogtown, Los Angeles has done a good job of cleaning up its air in a relatively short amount of time. Aside from the rise of use of catalytic converters for cars, how much does this have to do with the fact that L.A. is no longer a manufacturing powerhouse for the aerospace industry? Using L.A. as an example to learn from, how can China move away from manufacturing to services without sending shockwaves through its economy?

William Kelly (WK): In history, sixty years seems like a short time, but for those who lived it in Los Angeles it seemed like forever, especially for the roughly 10 percent of the population that suffers from asthma and other chronic respiratory diseases. And bear in mind the air in Los Angeles is still unhealthful, though much less so than even in the 1990s.

Aerospace really was a fairly minor source of air pollution in Los Angeles and its downsizing had more to do with the end of the Cold War, consolidation in the industry and the rise of Airbus and other competitors around the world. However, like virtually every other source of air pollution it was regulated and required to follow best practices and use the cleanest technology available. The fact is that around 1990, the LA area needed to cut emissions about 80 percent to meet health standards and to do that all sources had to be controlled. So the effort went far beyond the catalytic converter which was first required in the 1970s.

But without digressing, China can learn much from Los Angeles and California, but replacing manufacturing with services is not the answer. Instead, cleaning up the sources of energy in China is the key task that will bring the biggest environmental improvements, as well as much better control and treatment of waste byproducts from manufacturing that also pollute water, soil, and air.

The tragic thing we’re seeing now is that with the U.S. pushing the TransPacific Partnership trade agreement, we may replicate what happened environmentally in China in the 1990s in Vietnam, Malaysia, and other underdeveloped nations by helping to set up manufacturing that will be all coal powered. The coal plants in those nations already are being built in anticipation of the trade agreement.

AM: One of the more recent developments in China is the proliferation of citizen protests against new chemical factories. In your research, did you find this phenomenon to be widespread? How is the government (both local governments and the central government) reacting to these protests?

WK: The protests have been widespread, persistent, and often violent. The reason stems from fear of releases, particularly potentially catastrophic releases from chemical plants, but at the root is distrust of the public officials charged with regulating these plants.

Here’s a fact Americans might find hard to believe. In a nation with more than three times as many people as in the U.S., the Chinese equivalent to the U.S. Environmental Protection Agency has fewer people than work at the Natural Resources Defense Council, a few hundred. That’s in a nation that covers more land area than the U.S. too. Obviously that’s inadequate.

So as a result, the enforcement of standards largely falls on local and provincial government personnel, who are under the thumb of local and provincial Communist Party officials who are constantly wined and dined, if not controlled by industrialists. The common people know this, so they feel left to their own devices when these plants come to town.

The key to gaining trust here is for the national government to build up its capacity to enforce environmental laws and standards and for the national government to exert more control over provincial and local party officials by making their compensation and promotion contingent on environmental as well as economic performance.

AM: Perhaps most detrimental to China’s air quality is the widespread use of coal-burning as a power source. Given China’s growing demand for energy, and the cheap cost of coal as a resource, what are the necessary steps that the country needs to take to incentivize cleaner sources of energy? Is this already happening? If so, how?

WK: First, coal is the biggest cause of air pollution in China, particularly the terrible particle pollution we see in the pictures.

Solving the problem, therefore, is easy as ABC, anything but coal. Fortunately, China’s historic strength is in bringing technologies to scale, from the canals and roads of the dynastic days, to the great outpouring of digital devices we see today.

Now the nation is successfully turning to solar and wind power, where it’s become a leading nation both in manufacturing solar panels and wind turbines, and also deploying them in its grid. Indeed, China is the world’s biggest solar panel manufacturer.

Now, it’s beginning to do the same by turning to advanced batteries to store intermittent renewable power so it will be there at night and when the air is still. Coupled with the energy efficiency inherent in denser, urban living in small quarters we can hardly fathom in the U.S., China could be the next nation after Germany to get huge amounts of energy from renewable sources. In fact, it’s happening most energy analysts agree.

All that the Chinese have to do is follow Deng’s advice, to “be brave” and “walk with faster steps” when it comes to moving to renewable energy and to drop further development of coal.

AM: Looking ahead, do you think that urbanization will eventually lead to a better environment in China? In other words, once the new cities are built and the infrastructure is in place, will we look back on the last 3 decades as a small sacrifice paid for what could ultimately be a sustainable urban future with an intelligent grid, efficient public transit and green buildings? Or has the pace and scale of urbanization taken a toll on the environment that can never be rectified?

WK: When it comes to what China is doing with public transit, housing, and amenities for its people, one could argue it puts the U.S. to shame. In many ways, we have much to learn.

Clearly, even the casual visitor can see China is making a lot of the right moves on transportation and urbanization, moves that are setting it on a path when it’s fully developed toward much lower emissions per capita than in the U.S.

The danger is, however, that continuing to rely on coal to build out its cities will do irreparable harm to the world’s atmosphere by pushing up carbon levels to the point that triggers runaway global warming. The Chinese leadership ultimately is coming to grips with this, but needs to embark on a crash program to transition to clean energy.

Given their great communitarian tradition and amazing technical ingenuity—remember they had vastly superior technology to Europe even at the time of Marco Polo—the Chinese are fully capable of doing this, in fact leading the world on it. The ability is there, all they need to do is muster the resolve.

Many thanks to William Kelly for taking the time to answer these questions for us. Please be sure to read their new book The People’s Republic of Chemicals.

5 Questions for Shaun Rein, Author of “The End of Copycat China”

EndofCopycat China

More can happen in two years in a developing country like China than can happen in a decade or more in developed countries. And given this high speed of change, the information in business books about China’s economy can go out of date really fast.

That is why it is not surprising that although it has only been a little over two years since China analyst Shaun Rein released his first book, The End of Cheap China, he is back with another one. In that time span, China got a new leader in Xi Jinping, the one-child policy was significantly reformed, and Alibaba, the country’s biggest internet company, went public on the New York Stock Exchange.

The End of Copycat China is a natural follow up to End of Cheap China (which we featured a review of on this blog not long ago) and looks to build upon the research he’s been doing for the past decade on the ground in China.

I recently had a chance to chat with Rein about his new book and ask some questions about what he’s seen change in the past two years and, more importantly, the trends he sees influencing China’s development in the near future.

Adam Mayer (AM): Your previous book The End of Cheap China asserted that China is moving up the value chain from a land of cheap manufacturing to higher-end manufacturing and services. Since then, how have your initial observations been validated? Where is China today versus when you were doing research for your first book?

Shaun Rein (SR): When End of Cheap China first was released, many critics pounced on me and said that China would always be a low-cost manufacturing center. Over the last three years, however, my thesis has been proven right as labor and rents have gone up in double digits year on year in the manufacturing sector — China no longer is a cheap place to produce products. Companies like Nike have started sourcing more from even cheaper markets like Vietnam and Chinese footwear manufacturers like Huajian have opened factories in Africa.  When even the Chinese relocate to Africa in search of lower costs, that is when you know there is a tectonic shift in supply chains needed.

I also argued in End of Cheap China that China would not lose its manufacturing dominance because it has superior infrastructure and the necessary eco-system for manufacturing — I said that Chinese firms would move up the value chain which they have done. What might surprise people is just how fast many companies moved up the value chain. They are no longer transferring technology from western nations like Germany and the U.S. but actually focused on innovation which is where my new book begins.

AM: The title of your new book The End of Copycat China also suggests the ‘end’ of something China is known for (intellectual property transfer in this case) as a signal for its next phase of development. Is the perception of China as a land of copycats still a reality?

SR: Chinese firms were copycats for the most part of the last thirty years. The main reason was that there was so much low-hanging fruit to simply transfer technology from the West directly into China and to customize if needed for local markets. It was easy for well-connected (and corrupt) people to get land on the cheap and put up skyscrapers or secure long-term monopolies supplying various government agencies. But now that costs are so high and the public equity markets are giving high valuations to innovative Chinese firms like Alibaba and Tencent, Chinese companies are focusing on innovation more and more — it would be a mistake to discount their ability to innovate. This is a natural progression to what happening in South Korea and Japan.

Yesterday I was at Lotte World Amusement Park in Seoul. From the term ‘cast members’ to Indiana Jones look-alikes, even Lotte is seemingly knocking off Disney and the George Lucas/ Stephen Spielberg franchise.

Intellectual property was and remains a concern so it did not make sense for companies to invest millions of dollars in innovation because someone would likely steal it. When I interviewed top entrepreneurs in the book — and I interviewed the founders of JD.com, Qunar, Tudou for instance as well as the former CEO of Alibaba.com and an angel investor in Xiaomi — property rights and lack of enforced was an issue many brought up towards a barrier for innovation in China.  That said, the situation is getting better as the government is more likely to move to protect the interests of domestic Chinese firms hurt by copyright infringement than western players.

AM: Is there now a broad consensus among policymakers and business leaders in China that the country must innovate in order to continue on its path of economic reform? What are some examples of businesses or policies you’ve come across in your research that align with this goal?

SR: The Chinese government has definitely set the goal of innovative businesses taking up a larger part of the economy. Local governments are setting up innovation parks, like they did with the IT parks a business generation ago. Frankly, I am not sure that these initiatives will work as great innovation tends to occur in the private sector, often in small teams of entrepreneurs who think they can change the world. Chinese bureaucrats despite good intentions often do not understand and thus do not support new technologies which can hamper innovation.

That said, one sector that the government actively supports for innovation and which is seeing great growth is the bio-tech sector. Probably more than any sector I interviewed, except maybe mobile, biotech entrepreneurs were the most optimistic in China precisely because of the support the Chinese government is giving the sector from funding, equipment and opportunity to cooperate with academic institutions. Many said that the climate is better in China than in the US because of Obama administration funding cutbacks.

AM: Apple famously touts its products as “Designed in California, Assembled in China”.  This statement implies superior innovation power over Chinese counterparts. Yet with domestic Chinese businesses such as Tencent and Alibaba becoming more confident as innovators in their own right, what are the implications for Western businesses who have always felt safe in their role as the ‘innovators’ while using China as a factory?

SR: For years the ‘Made in China’ label had negative connotations as being cheap, dangerous. For much of the market that is true but can no longer work going forward. The first half of my book is focused on innovation — the second half is looking at consumer trends and how Chinese are moving away from copycatting the western dream of beauty and life as they define the new Chinese dream.

Importantly, there is a new found pride in Chinese-ness. Top Chinese firms like Xiaomi and Tencent are not hiding their Chinese heritage — Chinese consumers love it, support that move. For western companies, they need to understand that top Chinese firms are going to become global players competing on innovation and no longer the cheap but good enough positioning many Chinese companies competed with before.

AM: Your last book devoted an entire chapter to the real estate industry in China. To what extent does your new book discuss this topic and what are the implications for real estate as China’s economy shifts from one of manufacturing to services?

SR: Real estate plays a key theme in my book — including the high rents that are forcing retailers to think about e-commerce. The real estate sector in China obviously has some issues but they are not as serious as many analysts seem to fret. Prices might soften in the residential sector but there is little leverage in the marketplace. I am more concerned about some of the commercial developments that have gone up in the past few years because developers put too many Louis Vuitton stores as the anchors. The market can only sustain so many LV stores, especially with the anti-corruption crackdown.

But real estate is actually pushing forward a lot of innovation. I had an interview set up with Zhang Xin the CEO of Soho but it got cancelled last minute so I wasn’t able to include anything on Soho in the new book. But pollution has become such a problem in China that it is developers like Soho that are investing in the newest forms of technology for cleaning air, reducing carbon footprints. Chinese real estate developers are really at the clean technology forefront.

Thanks to Shaun Rein for taking the time to answer some questions for us. Please be sure to check out his new book The End of Copycat China.

Book Review: “The End of Cheap China” by Shaun Rein

Sensationalist stories about China’s supposed looming economic collapse captivate international headlines. While these articles might be entertaining to read or talk about, they nevertheless perpetuate an inaccurate picture of an evolving Chinese economy. The really big China story is perhaps too mundane for editors looking for catchy headlines. That is, the emergence of the largest middle-class in the world- beginning with Deng Xiaoping’s reform and opening up in 1978 and still being written today.

Upon my own arrival to China nearly five years ago, it became clear fairly quick that the younger generations living in urban areas would not be content to continue working in low-wage factories and construction sites forever. Following a similar arc of modernization and urbanization that developed countries went through in the past, albeit at a much accelerated rate, China ambitiously aims to move up the value chain economically.

This development is not easily grasped for those who haven’t had the opportunity to invest significant time interacting with people on the ground in China. Luckily we have Shaun Rein and his book The End of Cheap China to tell us the story of China’s evolving trends. The book was released in 2012, but the predictions Rein makes are perhaps even more relevant today than when it originally came out two years ago.

Rein, a consultant to foreign businesses looking to succeed in the China market, is a polarizing figure among the “China Watcher” community. His critics (mostly other expatriates in China) see him as an opportunist, shamelessly networking with high-level government officials and business leaders, and presenting a naively optimistic view of China’s future. Yet it would be a mistake to suggest that Rein is in denial of the tremendous challenges facing the country. Rather, his position is based on rigorous observation and analysis of the changing values of China’s upwardly mobile population. The End of Cheap China is anything but naive, interweaving Rein’s anecdotes of personal interactions with statistics and case studies.

Rein has been in China long enough to see beyond the physical changes to observe social shifts and how they impact individuals. In a chapter titled “The Modern Chinese Woman” he tells the story of an acquaintance he made while living in the northern port city of Tianjin. “Amy”, who Rein originally met in 1997, was a bashful young waitress at a local cafe, working hard and keeping her head down.

When Rein returned to Tianjin more than a decade later and ran into Amy, he found a confident, stylish woman complete with a designer bag and trendy clothes. After catching up with her, he learned she had left her waitressing job and had been working for several multi-national companies doing business in the city. Her prospects turned out to be so good in fact, she expressed interest in becoming an entrepreneur and starting her own business. Opportunities like this abound for young and savvy Chinese urbanites. Competition is fierce in China’s cities, but compared with the chaos that ensnared the country during most of the 20th Century, there has never been a better time to be a young person in China.

Perhaps of most interest to readers of this blog is the book’s insight into China’s real estate sector, which has an entire chapter dedicated to discussing the subject. Near the beginning of the book, Rein demonstrates his deep understanding of how the real estate game works under a case study section titled “What To Do and What Not To Do in China”:

Real estate is intentionally ramshackle. Many Westerners say Chinese real estate companies exhibit poor urban planning. A common complaint by visiting Westerners is that malls are not built attractively, or that parking lots are built on prime building locations, like on a riverside, while shopping complexes and restaurant zones are built across the street without good river views.

Criticisms like this does not survive basic analysis. Rules force developers to start construction soon after buying land from the government. It is illegal to hold on to land as an investment, so real estate developers who think land values will continue to rise either will build something as cheaply as possible, in the hopes of knocking everything down and rebuilding when prices go up, or will put up parking lots to fulfill regulatory requirements and delay prime construction on the property until later.”

This sober explanation of China’s real estate industry is not something you’re likely to read in the pages of the New York Times or one of the countless alarmist articles about China’s “ghost cities”. Rein goes on to debunk the popular opinion by perennial China bears such as economist Nouriel Roubini and hedge fund manager James Chanos that the country has over-leveraged itself on infrastructure development.

Development of new highways and rail lines (both urban metro lines and inter-city high-speed rail) might seem superfluous to outsider observers, but these transportation networks are key to successful urban development, including the availability of affordable housing. As Rein writes: “The need for less-expensive housing and commercial space will require urban areas to spread out, and for all infrastructure spending to be used on railroads, subways and airports.

The book’s chapter on real estate does acknowledge some problems within the industry, including the lack of quality management in new commercial developments, which may cause some developers to fail. As a matter of fact, this is already happening in some cases, yet Rein points out that because commercial real estate only accounts for 20% of new construction, any serious problems in this sector are unlikely to have a catastrophic impact on the overall economy.

The underlying message throughout the book is a warning to foreign businesses to not assume that China will always just be a “cheap place to manufacture things”. On the contrary, it is important at this stage of economic development for savvy investors to seize the opportunity in selling to the rapidly growing Chinese consumer class. Granted, many foreign businesses have already seen this opportunity, but Rein warns of the competition from domestic Chinese firms such as Haier (in the home appliances market) and Tencent (in the social media space) who are developing strong brand awareness and consumer trust within the local market.

Perhaps it is fitting that this review end with a mention of successful home-grown Chinese brands as Rein recently announced a follow up book coming out in November of this year titled “The End of Copycat China“. Up until this point, Chinese companies have been seen by the international community as ‘copycat artists’ stifled by a controlling government and an inability to think creatively. Holding onto this view going forward is dangerous, not only for investors involved in China but for global brands competing for market share internationally.

Rein’s new book is bound to be insightful and timely. In the meantime, if you haven’t already, I highly recommend The End of Cheap China as an excellent guide to understanding the current state of economic development in The Middle Kingdom.

China In Africa: An Interview With Go West Project

African Union Building A local looks up at the new African Union Headquarters in Addis Ababa, Ethiopia. The complex was funded entirely by Chinese money. Photo Credit: Go West Proejct

In 2009, China surpassed the U.S. to become Africa’s single largest trading partner. Yet the burgeoning relationship between China and Africa is no ordinary trading arrangement. Rather than colonizing the continent as Western powers did in the past century, China is trading infrastructure development and urbanization expertise for access to Africa’s vast natural resources. This re-balancing of trade has yet to be studied in depth as it is probably too early to tell what the impact of China’s involvement in Africa will have on the broader world’s economy.

What we can observe is the immediate impact China is having on Africa’s urban development. Luckily we have Dutch researchers Michiel Hulshof and Daan Roggeveen of the emerging cities think-tank Go West Project to explain to us what is happening on the ground.

I first met Hulshof (a journalist) and Roggeveen (an architect) at the 2011 Chengdu Biennale where they presented their research on China’s developing western metropolises (hence the name of their think-tank). Their research culminated in the book How the City Moved to Mr. Sun – China’s New Megacities (2011), which looks beyond the so-called 1st Tier cities of Beijing and Shanghai to tell the story of urbanization in the country’s heartland.

Now Hulshof and Roggeveen are looking even further, beyond China’s borders, to study what the Chinese urbanization experiment means for Africa’s cities. They were kind enough to take the time to answer some questions for us about their initial research:

Adam Mayer (AM): Please give us a summary about your research in Africa and what interested you about studying China’s impacts on the continent.

Go West Project (GWP): In our book “How the City Moved to Mr Sun” we described the mechanisms behind the emergence of megacities in Central- and West-China. We are currently working on a new study into China’s involvement in African urbanization. Given the growing impact of China in the world, and the strong ties between China and Africa, one could think of the physical impact that China has in Africa.

It seems the Chinese are already exporting parts of their urban model to Africa: new “Special Economic Zones” in Zambia, Nigeria and Ethiopia, Chinese residential models in Angola or Kenya and Chinese roads, airports and railways all over Africa. There’s also a new approach of “soft power” with Chinese-led African newspapers and television stations, Chinese language schools, university grants for African students and professionals, and Chinese medical aid projects in Africa. We think this phenomenon deserves an unprejudiced look as to what this means for the development and the future of African cities.

AM: What are those impacts that China’s economic development has had on Africa? Are there certain regions or countries in Africa that have benefited more from China’s business interest in the continent?

GWP: These impacts are both tangible and non-tangible. On the tangible side, China constructs roads, railroads, ports, airports, but also telecommunications structures, fiber optic networks, dams and even satellites. It builds schools and offices and has even given the African Union their headquarters as a present. On the non-tangible side, there are grants for students, increased influence of the media – CCTV has already 80 journalists in their Nairobi office! – and Confucius institutes. Of course, the countries with resources are very attractive to go to for the Chinese – but not only them Royal Dutch Shell is already for decades involved in Nigeria.

AM: China is trading its development and urbanization know-how to certain countries in Africa in exchange for resources- What are some prominent examples of infrastructure or building projects built by the Chinese in Africa?

GWP: The most symbolic one is the structure of the African Union building: a 200 million dollar gift from China to Africa. The building was designed in China (by the Tongji Architecture Planning and Design Institute), built with Chinese materials, by a team of half Chinese and half local workers. In Nairobi, we came across the Great Wall apartments on Beijing road, a development by a Chinese real estate developer. The most amazing example is of course the new towns of Kilamba Kiaxi in Angola, where CITIC developed and built 750 highrise apartment blocks.

 Kilamba_KiaxiKilamba Kiaxi in Luanda, Angola

WorkersAfrican & Chinese Construction Workers. Photo Credit: Go West Project

AM: One criticism of China’s venture into Africa is their use of imported Chinese labor to construct new cities rather than using local labor which would help job creation in the region. In your research did you find this to be an issue?

GWP: This is only partly true, and differs strongly from country to country and from project to project. More and more, the Chinese are aware of the fact that hiring locals improves the engagement of a project. What you see very often is a construction site (or a factory for that matter) with Chinese site supervisors, and local laborers.

A way to have local people profit more is not to hire Chines companies, but local companies for construction jobs. However, local companies can often not compete with Chinese ones in speed, price and quality.

AM: Based on studying China’s influence in Africa, do you feel that China is setting a new standard for developing county’s around the world that aspire to urbanize and grow their economies?

GWP: Africa’s urbanization is staggering. Africa’s urban population, which was 395 million in 2010, will be no less than 1.2 billion in 2050. That means Africa’s cities will have to accommodate an extra 40,000 people every day for the coming 15 years. If there’s one country in the world that has experience with such an enormous rural to urban transformation, it is China.

However, implementation of Chinese strategies on African soil seems so far hardly possible due to differences in political and economical structures.

Therefore, we think that the impact of Chinese presence in Africa will depend very much on the local conditions, and will strongly differ from country to country and city to city.

Michiel Hulshof is partner at Tertium, an Amsterdam based office for strategic communication. Daan Roggeveen is the founder of MORE Architecture, Shanghai and Curator at the University of Hong Kong/Shanghai Study Centre.

Be on the lookout for further research on this topic as Go West Project is currently preparing a theme issue of the magazine Urban China, with contributions by Brechtje Spreeuwers (NL), Huang Zhengli (CN), Njeri Cerere (KE) and Paulo Moreira (PT).

China and the Legacy of Steve Jobs

Fake ‘Apple Store’ in Kunming

It is not hard to understate the influence that Apple has had on China. If we examine the role the country plays in the supply-chain of Apple products, then China’s relationship with the company is undeniable. It is safe to say that without China’s contribution to the manufacturing and assembly process, Apple’s stylish products would be unaffordable to the average consumer around the globe.

That’s why last year when a string of suicides hit Foxconn, the company that manufactures products such as the iPad and iPhone, Steve Jobs was quick to announce that Apple would look into the working conditions. Jobs, a marketing genius, knew that negative PR associated with Foxconn would hurt Apple’s sleek and stylish image in the U.S.

What commentators in the U.S. failed to notice is the relative ambivalence of people in China regarding the Foxconn suicides. When I asked my Chinese colleagues what effect the incident had on their perception of Apple, they responded that there was absolutely none. Not only that, they defended Foxconn by saying that the rate of suicides among workers (there are tens of thousands of them) is not abnormal for society at large.

The willingness to defend Apple and its manufacturer is a testament to the huge popularity of the brand in China. From first-hand observation, it seems that Apple products are as ubiquitous here as they are in my native Silicon Valley. It is certainly not only about function- rather, owning an iPhone or iPad is akin to owning a luxury handbag from Hermes or Prada. I know many people who are willing to spend 2 or 3 months salary or even borrow money from friends to purchase an iPhone.

Perhaps more baffling is the fact that Apple products cost more in Mainland China than they do outside. This defies logic given that most of the products are made here…one would think that a reduction in transport cost would bring the price down. The reality is that despite being ‘made in China’, Apple products are treated as ‘imports’ and are taxed as such. This is done to encourage the consumption of domestic products rather than foreign competitors.

The high price point has done nothing to deter Chinese consumers from buying Apple products. Even when the comparable Lenovo tablet computer is advertised for 1000 RMB (~$156.00 USD), Chinese consumers are willing to pay 4 to 5 times that price just to have the iPad.

Furthermore, the desire for Apple products has created an illicit industry of smuggling from Hong Kong and other places. Not long ago, authorities shut down a zipline stretching across the border from Hong Kong into the Mainland city of Shenzhen. Flying on that zipline was none other than shipments of  iPads. Women in overcoats concealing a body covered in iPhones and iPads have also been caught trying to cross the border between Hong Kong and Shenzhen.

In a country known for its knock off products, Apple products are worth the price of their authenticity (even if those real products are purchased in ‘fake’ Apple Stores). Given this fervor, the overwhelming reaction from Chinese Apple fans upon hearing about the passing of Steve Jobs is not surprising. Netizens took to Weibo (China’s ‘Twitter’) commemorating his contributions to the world. Others visited Apple vendors around the country to offer their condolences in person.

Steve Jobs’ popularity in China demonstrates a universal admiration for ground-up innovation and entrepreneurship. Despite having a reputation as a culture that discourages innovation and forces workers to ‘toe the line’ in order to maintain social stability, China’s rising living standards and gradual shift to consumer economy will create an environment more conducive to the kinds of innovations that have come out of places like Silicon Valley in the past.

American economist Panos Mourdoukoutas disagrees with this notion in a recent Forbes article (Why China Doesn’t Have It’s Own Steve Jobs). Mourdoukoutas cites the ‘nature of Chinese institutions’ and ‘lack of incentives to develop pioneering products’ as reasons for this being the case. While looking back at the past few decades, his observations might be correct, looking into the future, he could not be more off the mark.

As I have said before, China’s economy is in a constant evolutionary state. What may appear a static, archaic, and centrally controlled beast from the outside is certainly not reality within China. One only needs to look at the evolution of China’s neighbors, Japan and South Korea- both places once known as bastions of intellectual property theft- to get an idea of where China is headed in the innovation department. Only this time, the scale will be much larger.

Only once the country’s ‘hardware’ (infrastructure, buildings, etc…) is in place, will China make the full shift to a more consumer driven economy. Mourdoukoutas finally acknowledges this reality at the end of his piece:

“To have its own celebrated entrepreneurs, China must develop a consumer-centered market economy that releases the ingenuity and creativity of its people in the search for novel ways to change consumers’ lives, amassing wealth for themselves in the process.

On the ground here this is already happening, but the process might be too gradual for outside observers to see. If reverence for Steve Jobs is any indication, China is in for a golden age innovation and entrepreneurship…the people here are hungry for it.

Local Debt Adding Fuel to Bearish Outlook on China

Credit rating agency Moody’s recently released a report claiming that Chinese financial auditors have understated local government debt by half a trillion dollars. This is no small estimate, and the thought of so many non-performing loans on bank balance sheets is enough to make any seasoned investor bearish on China.

Of course, the majority of debt is fueled by lending that is going to local provincial and municipal governments and developers to fund new infrastructure and building projects. Banks are making these loans because of direct orders from the top-level of China’s central government. These orders were stepped up significantly after the 2008 world financial crisis to keep the country’s growth engine humming along as the export market fell off a cliff.

The New York Times wrote an article acknowledging that China’s building boom is stirring up fears of debt overload. To get a better understanding of the situation, the NYT examined the central China city Wuhan to see what the process of urban development entails from a financing standpoint.The piece does a good job of explaining how municipal governments often set up separate entities (state-owned) to help finance and construct large-scale infrastructure projects.

In the case of Wuhan, the city set up an entity called ‘Wuhan Urban Construction Investment and Development’, or Wuhan UCID. According to the NYT piece, Wuhan UCID “has over 16,000 employees, 25 subsidaries, and 15 billion dollars’ worth of projects, including roadways, bridges and sewage treatment plants.” Sun Zhengrong, a spokesman for Wuhan UCID, admitted to the NYT that the company is  heavily in debt.

China’s mode of development is contrary to everything that is sacred to Chicago school economists and free-market fundamentalists. If it were up to the ‘market’ to decide the fate of entities like Wuhan UCID, it should fail tomorrow because of its tremendous liabilities. There is no way that Wuhan UCID will ever be able to recoup its investment in things like bridges or sewage treatment plants because these kinds of investments don’t traditionally turn a profit.

Infrastructure investment is necessary for any developing economy. China understands this and is willing to take the risk of ordering its state-owned banks to make loans towards this type of investment (even if they are never paid back). In a sense, entities similar to Wuhan UCID (of which there are countless across China) and the state-owned banks lending to them are ‘too big to fail’.

When entities like Wuhan UCID do default on their loans, it is likely to dissolve into smaller pieces or restructure into something different to avoid the responsibility of paying them back. The ‘failure’ of these entities to pay back loans also ensures that the central government maintains control over local governments.

What about the banks? The reality is that China’s banks are nothing more than conduits for the government to spend money. They are in no hurry to recoup their loans- rather they have a longer view and see the hundreds of millions of new Chinese homeowners as a stabilizing force in the banking system (and the social system as well). China’s leaders also realize that the era of cheap labor won’t last forever, thus the rush to build the country’s infrastructure.

Property developers, whether state-owned or private, are also tools of the government, pressured into acting fast to build or risk losing land they had successfully bid on.

What are the implications for overseas investors? It is important, first, to acknowledge that the Chinese government doesn’t care about outside investment. Overseas companies who gain access to the China market do so because of the potential to acquire technical know-how. When it comes to banking and investment, China is very closed off. Foreigners have barely any access to the real estate market and China’s currency is still not easily convertible despite pressure from developed economies around the world.

The closed nature of China’s economy, as well as its huge foreign-exchange reserves, is a hedge against the potential damage that over-investment in urban development could cause. If there were to be a problem, China could always do more to open up to foreign investors to prop itself up again. China could also do a lot more to promote internal consumption, including float its currency and remove tax barriers on foreign goods.

The time for these measures has not arrived yet. Despite all the hype of being the world’s number two economy, China is still very much a developing country. Investment in infrastructure makes a lot of sense at this point given the how it will benefit the country now and well into the future.

China Linking Southeast Asia with High-Speed Rail

Kunming, Yunnan Province:   China’s Gateway to Southeast Asia

China receives a lot of well-deserved recognition for its expanding high-speed passenger rail system. Now China’s rail ambitions are extending well beyond its borders into neighboring countries. This April, construction is to begin on a rail line linking southern Yunnan province with the country of Laos to the south.

With cash in hand and the ability to build such a rail line, China is paying for the majority of the construction cost while Laos will only be responsible for 30% of the cost. This is yet another example of China exercising its policy of ‘infrastructure diplomacy’- that is, helping other developing nations pay for and build new infrastructure to promote favorable relations and gain access to natural resources.

China can now be seen practicing this form of infrastructure diplomacy in everywhere from sub-Saharan Africa to Central Asia and even South America. Yet nowhere are the implications of this approach to foreign policy more manifest than in Southeast Asia. This is not only due to the close proximity of the region to China’s southern border, but because Southeast Asian nations are about to undergo their own development transformations and China is looking to establish a  key role in the process.

China’s ambitions are so high in Southeast Asia in fact that the country hopes to someday link via rail all the way from Beijing to Singapore. Plans are also underway to connect China to Cambodia and Thailand. Much to the dismay of human-rights activists, China also has very good relations with Myanmar despite that countries questionable leadership.

Vietnam is a unique case in that their sense of autonomy is especially strong in the region. In particular, Vietnam does not shy away from criticizing China over overextending its claim over the adjacent South China Sea. Territorial disputes could arise, but chances are likely that Vietnam and China will find a way to work together that will mutually benefit one another.

In China, Kunming, the provincial capital of Yunnan, stands to gain tremendously from the growing ties with Southeast Asia. A city of about 3 million people, Kunming is already China’s gateway to the region and boasts a diverse array of minority cultures with historical ties to countries to the south. Though long relegated to 3rd tier status, Kunming is on the rise to become what will be an important international business and transportation hub for China and all of Southeast Asia.

GoKunming: Trans-Laos Railway Construction to Start in April

Monsters & Critics: Construction on Laos’ High-Speed Rail Set to Start in April

Post G-20 Hangover: Trade Wars, Currency Manipulation & More

Downtown Seoul

The G-20 meeting in Seoul earlier this month left in its wake a trail of uncertainty regarding the state of the global economic system. The U.S. received its fair share of criticism over its ‘QE2′ quantitative easing measure. ‘Quantitative easing’ is  essentially akin to the Federal Reserve Bank printing more money. The goal here is to help stimulate job growth in the U.S. by weakening the dollar. Forbes columnist Shaun Rein explains why quantitative easing might actually be  a terrible mistake.

Treasury Secretary Timothy Geithner denies the U.S. is manipulating its currency while continually berating China over the low valuation of its RMB. With QE2, the United States can no longer taker the moral high-ground because it has now entered the currency devaluation game. The intent of QE2 is to try to direct investment and job growth back to the U.S. but it will probably have the opposite effect: lowering the standard of living of American by causing inflation.

The U.S. government along with the Federal Reserve is trying to incentive people to start borrowing on credit again with super-low interest rates. Quantitative Easing also aims to bring back manufacturing jobs by killing the U.S. dollar. This is a dangerous game as I have pointed out before (Floating China’s Currency Will Not Bring Manufacturing Jobs Back to the USA). Unfortunately, for America and its citizens, the standard of living has nowhere else to go but down.

China on the other hand is waiting to unleash the power of the Chinese consumer (by letting its currency value rise) when the time is right. That time has not arrived yet. It is much easier to give your citizens more purchasing power when all they have known before is poverty. When the Chinese government is ready, the RMB will rise and the Chinese consumer will be busy shopping. The New York Times magazine spells out the situation exceptionally well in a recent piece: Can the Chinese Become Big Spenders?

The actions by the Federal Reserve have already managed to compel China to enact measures restricting foreign investment, or so-called ‘hot money’, into its domestic market. One example of this is the booming property market, where China just implemented a new rule limiting foreign companies to purchasing  only one commercial property, intended for its own use. In addition, foreign individuals are limited to buying only one residential property in mainland China.

The G-20 managed to accomplish nothing except to exacerbate currency disputes. The recent attacks by North Korea on South Korean territory could also negatively influence trade relations even further by escalating political tensions between the U.S. and China. Assuming tensions subside, it is in the best interest of all parties involved to resist currency anxiety in order to avoid a full on trade war.

Additional coverage on the Post G-20 Hangover:

Forbes: Summers and Economic Fluctuations

Forbes: Why Ben Bernanke is Wrong

New York Times: Currency Fight With China Divides U.S. Business

Wall Street Journal: Bernanke on China, Translated

Wall Street Journal: Barney Frank: GOP ‘Joining the Central Bank of China’

China, Japan, America

Japanese Retail Chain Uniqlo at Chengdu’s Chunxi Lu Shopping Street

After spending the previous two weeks in the U.S. visiting friends and relatives, I returned to chaos in Chengdu last week. Just a few blocks from my apartment, protests were being held at the city’s main shopping street, Chunxi Lu, against Japanese-owned businesses. I had no idea this was going on until I was alerted by my friends over at Chengdu Living who were there documenting the scene with photos and video.

This anti-Japanese demonstration came about due to a recent dispute about the ownership of the Diaoyu Islands in the Pacific. The cultural rift between the two countries goes deeper than that though, with bitter feelings about Japan’s invasion of China during World War II still prevalent among those living in mainland China.

Now with China having recently surpassed Japan as the world’s second largest economy, the Chinese are feeling more confident about their growing influence in the world, and especially in East Asia. The protests against Japanese businesses in Chengdu reflect this newfound confidence.

Strangely, China and Japan are very similar in that both are ethnically homogenous countries, with strong cultures and long histories. The successful development process of both countries (and South Korea as well) can be attributed to this fact. Yet too much of the same kind of ethnic pride, if taken to extremes, can lead to radical patriotism- a kind of ‘us versus them‘ mentality. North Korea currently possesses this radical patriotism. Unfortunately, the Chengdu demonstrations hinted at this poisonous mentality as well.

On the other side of the Pacific, the United States is suffering from the opposite affect- a stark lack of consensus among the population. This is exacerbated by fact that America is an ethnic melting-pot, making cultural unity more difficult to achieve. Citizens and politicians alike cannot seem to agree on anything, therefore, nothing happens to help repair the U.S. economy.

Perhaps the lack of ethnic unity is one of America’s primary strengths. After all, there is a lot to be said for a place where people from all over the world are welcome to make a better life for themselves (at least this was the case up until recently). There are some groups though, namely the fringe element known as the ‘Tea Party’, who oppose the notion of openness upon which America built a successful nation.

The Tea Party is America’s own version of radical patriotism. They purport to be about putting an end to frivolous government spending, when in reality it seems to be the last gasp of air for a dying Anglo-Saxon American hegemony. Instead of putting a stop to ALL government spending, Tea Party members and other concerned Americans should be encouraging the U.S. government to make investments in things that promote opportunity (cutting-edge infrastructure, IT research and development, education).

America will never be an ethnically homogenous country like China or Japan. Yet the U.S. can take a cue from the success of East Asian countries by focusing on investing in nation-building rather than sitting around waiting for opportunity to magically come back to its shores.

China, America, Paul Krugman

Every few months, Nobel Prize winning economist and New York Times columnist Paul Krugman writes an opinion piece lambasting China for ‘manipulating’ its currency, the renminbi (RMB). Whenever he brings this particular issue up, Krugman argues that China is undermining America’s (and other countries) manufacturing competitiveness.

I have responded to Krugman’s previous commentaries about the Chinese currency issue before (U.S. – China Trade Complications) and discussed why letting the RMB float will not bring manufacturing jobs back to the U.S. Krugman doesn’t seem to be getting the message based on yet another  Op-Ed he penned titled China, Japan, America.

He begins by mentioning Japan’s recent complaint about China’s trade policies and then continues on wondering why U.S. politicians cannot do the same by also taking a tough stance. Actually, just to be clear, there have been those in the U.S. Congress and White House who have been vocal about what they see as China unfairly manipulating the value of the RMB- but these voices have done little to change China’s currency and trade policies.

Freeing the RMB peg and letting it float would be a very dangerous move domestically for China. If the value were to rise too quickly, making manufacturing costly and uncompetitive, the result would be a huge surge in unemployment. This could lead to potentially devastating social instability, a reality which Krugman completely ignores.

Another reality he ignores is the fact that U.S. corporate executives and the shareholders of their companies directly benefit from the cheap cost of outsourcing to China. Does this hurt the average American worker? Absolutely, but this is no surprise- American business executives and corporate managers are the best in the world at ‘minimizing overhead/maximizing profits’.

In the end, U.S. politicians will pay lip service to pressuring China over the RMB value, but it is doubtful any real policies will come out of Washington that would end up hurting trade relations.

The New York Times: China, Japan, America

UPDATE:

Just a few days after Paul Krugman’s aforementioned opinion piece, the New York Times produced another editorial about the China currency issue. This time, the NYT editorial board applauds U.S. Treasury Secretary Timothy Geithner’s recent comments encouraging Congress to do something about the shaky China trade relationship.

Mr. Geithner is following the lead of Japan’s minister of finance (who Krugman mentioned in his piece) in anticipation of the G20 finance ministers meeting next month. Geithner made clear to Congress that keeping the RMB value low against the U.S. dollar is not in China’s long-term interest, as it not only hurts the U.S. and other developed countries, but developing nations as well.

I certainly doubt that China plans on keeping the value of the RMB low forever. Long-term, Chinese leaders face the daunting task of peacefully directing the evolution of its huge economy. Right now, the country is still an economy largely based on low-cost manufacturing. That is quickly changing though, as China’s central government directs investment into IT, R&D and other diverse sectors.

Only when the Chinese economy is diverse enough beyond low-cost manufacturing will the Chinese leaders feel safe letting the RMB rise in value.

The New York Times: Mr. Geithner and China