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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.

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.

  • Christian Hermann - maybe China is good in micro innovations, small improvements, modifications and enhancements, but innovation by the original meaning is not yet happening in China. Innovations are big disruptive or impactful new ideas that change systems holistically or introduce something completely new. Everything else is just an improvement for certain needs, or if you want, a micro innovation with a regional purpose.ReplyCancel

  • The End of Copycat China | URBACHINA - […] 5 Questions for Shaun Rein […]ReplyCancel

View over Victoria Harbor towards Central- the center of the pro-democracy protests

Hong Kong is an unlikely setting for massive political protests. The city, known for its open global trading culture, is a paragon of economic freedom. Yet many would argue that the economic freedom enjoyed by Hong Kong’s citizens has not kept pace with the level of political freedom.

Case in point: at the time of this writing, pro-democracy protests in Hong Kong have taken over the city; spilling over from the city’s central business district of Central into the neighborhoods of Causeway Bay and to Mong Kok across the harbor in Kowloon. Prompting this unprecedented massive protest was the Chinese Central Government’s decision last month to allow only committee-approved candidates to run for Chief Executive (Hong Kong’s highest political office) in what was supposed to be the city’s first public vote in 2017.

Beijing’s decision to vet Chief Executive candidates before they are permitted to run for office sent a signal to Hong Kong citizens that perhaps the Central Government is not fully comfortable embracing the idea of ‘One Country, Two Systems‘. That being said, while on the surface this appears to be primarily a political protest, underlying much of the frustration of protestors are economic issues resulting from a flood of Mainland wealth entering Hong Kong.

To understand why this may be the case, it is important to look at Hong Kong as a ‘city’ first rather than a former British Colony and current Special Administrative Region of China.

As anyone who has visited the city knows, Hong Kong is one of the most compelling urban places in the world. Spanning across Victoria Harbor, from Hong Kong Island to the Kowloon Peninsula and beyond to the New Territories, the city’s natural geographical setting is stunning. Add to that the forest of svelte skyscrapers against a backdrop of steep mountains and you get a visual dynamism that is unmatched by any other city.

Urbanistically, Hong Kong functions like a well-oiled machine. The always on-time metro system spans to the far reaches of the city and mixed-use developments everywhere promote lively street-level activity. The city’s airport is one of the most well-connected and efficient in the world. The tourism/hospitality industry is gold standard and booming.

Given all the assets possessed by the city, what then is Hong Kong’s problem?

Short answer: the cost of living is out of control.

In a sense, Hong Kong is a victim of its own success. Thanks to its open banking system, global capital flows into the city relentlessly. Investment in Hong Kong property, primarily from wealthy buyers from Mainland China, drives up the price of real estate to astronomical levels out of reach for most locals.

Exacerbating the housing affordability crisis in Hong Kong is the lack of land to build new real estate to meet the high demand. Demographer Wendell Cox’s research has even found Hong Kong to be the world’s most unaffordable housing market.

The protests in Hong Kong are directed at the Chinese Central Government, but they might as well be directed at China’s capital flows into the city. To put it into perspective, this is a semi-autonomous highly developed city of 7 million, adjacent to a developing country of 1.3 billion. Hong Kong is the closest safe harbor for wealthy Mainlanders to put their money. On top of that, millions of Chinese tourists come to Hong Kong each year to go on shopping sprees, buying luxury goods, sales-tax free, that would be more expensive to purchase in the Mainland.

Given the severity of the situation, it is no wonder that native Hong Kong citizens are taking to the streets in protest. Yet as Hong Kong is already a relatively free city, unfortunately I do not think that more ‘democracy’ will help the solve the problems that Hong Kong protestors are most concerned about (cost of living, loss of cultural identity, etc…).

On the contrary, the solution for the city’s woes would be for the rest of China to become more like Hong Kong. That is- more global, economically open and possessing a banking system that investors can trust. Mainland China is not there yet, but proposed initiatives such as merging the Pearl River Delta into an interconnected ‘mega-region’ and the Shangahi Free-Trade Zone are steps in the right direction.

Ultimately the point is to take the pressure off Hong Kong. This could be achieved by making other cities in China, such as Shenzhen or Shanghai, more open economically, so that capital flows more freely through the Mainland.

The Chinese government up until now has hesitated in doing this. Perhaps the protests in Hong Kong will be a wake-up call to speed up reform. My feeling is that this will happen eventually and hopefully sooner than later.

OLYMPUS DIGITAL CAMERAThe Economist Intelligence Unit (EIU) shared with us their new study on “China’s Urban Dreams 2014” – an update on the country’s urbanization program. With all the uncertainty about China’s property sector in the news recently, this in depth analysis gives some clarity to the often murky topic of Chinese development.

While Western media tends to paint China with one large brushstroke when discussing the country’s property sector, the reality is that real estate markets vary greatly from region to region. China, like the U.S., is a large, diverse country with many different cities and regions with varying strengths and weaknesses. If there is one takeaway from the EIU study, it’s that not all regions are created equally, and going forward, there are bound to be winners and losers.

Before we delve into the details of regional urbanization trends, let’s take a look at where China as a nation stands today. The country’s urbanization ratio is right around 50%, pretty much on target with the Chinese government’s projections. China’s per capita GDP is still relatively low- above India and Nigeria but below Brazil, Russia, and South Africa. Of course, China’s enormous population is a contributing factor to this being the case.

By 2020, the Chinese Government wants to bump up urbanization to 60%.  This will require another 100 million people in cities. It is important to keep in mind though, that this will not only be a result of migrants explicitly “moving” to the city, but urban boundaries continuing to expand into the surrounding countryside. As cities grow in China they annex the land around them, transforming once rural land into urban real estate.

Another key factor in meeting urbanization targets is household registration (hukou) reform, which would help afford migrants a form of permanent residence status in a given city.

Where will these 100 million new urban residents live in 2020 and beyond? According to the EIU study, Guangdong Province will pick up the lion’s share of new urban development. This is not surprising given that the Pearl River Delta region is already the most urbanized in the entire world and is further developing in a manner to help better integrate the region as a whole.

Central province Henan is also urbanizing rapidly, as is the Beijing-adjacent province of Hebei. Yet both of these provinces won’t reach the urban populations projected for coastal provinces Shandong and Jiangsu.

Perhaps unsurprisingly, it is projected that the direct-controlled municipalities of Beijing, Shanghai and Tianjin will have the highest rates of urbanization by 2030. The Central Government has made it a priority to integrate Beijing, Tianjin and the adjacent province of Hebei into one large mega-region of 100 million people called “Jing-Jin-Ji“. The aim here is to take pressure off of Beijing, which suffers from traffic gridlock, pollution and astronomical housing prices.

Along with the announcement of the formation of the Jing-Jin-Ji mega-region was a move by Hebei Provincial officials announcing that some of Beijing’s Central Government functions will move to the city of Baoding, 150 km southeast Beijing. Although specifics have yet to be articulated, this is a clear indication that the China plans to decentralize its government functions.

WEB - Victoria Lai - Access China - Demographics.inddOverall it looks as if the coastal areas of China will continue to urbanize at high rates while inland regions lag a bit behind. Although there is a wave of manufacturing moving from coastal areas to inland provinces, there still appears to be a logistical advantage being on the coast. To see where China is heading, perhaps it is best to look at the Pearl River Delta, which has led the way since initial economic reform and continues to lead the way today.

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.