10 december 2002

A giant awakens

Introduction

China’s entry into the WTO this year will have a huge impact on both China’s internal political and economic environment and the world’s global economy – not to mention multinational corporations. Why multinational corporations? Well, as agents of the ongoing “globalization”, China is an interesting country to invest in – also for its huge consumer market.
Together with Mr Drucker – the management consultant – who asked Mr Welch (the former CEO of GE): “If you already weren’t in this business, would you choose to enter it now? And, if the answer is no, what are you going to do about it?” multinational corporations also have to ask themselves this question.

In this research paper I will present recent political and economic developments in China and its implications for multinational corporations. I will take the telecom industry as an example.

WTO ENTRY
Possibly, Chinese government entered the WTO under strict rules; and there were aggressive reforms by the Chinese government to join it. Some point out that in the years before, many trade barriers for goods had been abolished or at least substantially lowered. Others mention that this only affected goods, and not services (like telecommunications, banking – which will be discussed further in FOREIGN DIRECT INVESTMENT).

The WTO will mean even more cuts in tariffs and greater market access for foreign companies, which means more competition for many Chinese companies. Anyway: due to the WTO entry, China managed to bring in more foreign direct investment (FDI). A big question will be whether the almighty Politburo and Communist Party will benefit from opening its (economic) borders or will fail because of it.

There is a lot of pressure (but also benefits) if China manages to keep its promises it made to the WTO. What are the short- and long-term troubles China will face? Firstly, it has to keep a steady inflow of (in order to comply with WTO’s standards – high quality
[1]) FDI and keep its GDP – 7.3% in 2001 [2] growing.

This brings me to the second crucial point: the labor issues. There is much unemployment in China: especially in the so-called Rust Belt (northeastern part of China). Furthermore, since the price of grain is 15-20% higher in China than the rest of the world, prices will drop under WTO pressure and consequently farmers will have to look for a different job. Officially the unemployment rate stands at 3.6% in urban areas, more likely it is between a grimmer 8-20%.

Thirdly, there is much government debt. This has to do – among other reasons – with the massive government spending during the past years (I will come back to this later). Furthermore, there is the pension problem. And finally, the stock market is filled with unhealthy state owned enterprises.

To add to the misery, there are pessimistic views with regard to China’s (near) future. Mr Chang says that China's entry to the WTO would “shake the government to its foundations”. Of the banking system, he wrote: “It is here (...) that the end of the modern Chinese state might well begin.” Mr Chang said China had about five years in which to sort out its financial mess, including a fast-growing budget deficit, or else it faces “the laws of gravity”
[3]. Mr Hu – who wrote the popular essay “China: the Danger of Turmoil” writes: “China has not yet crossed the most difficult hurdles (...) so I say the real unrest is yet to happen. What happened in 1989 was just a preliminary stage.” Is there any reason left for optimism?

THE COMMUNIST PARTY AND THE CHINESE ECONOMY
Mr Hu has three positions to take over: general secretary of the Communist Party, state president, and chairman of the Central Military Commission (i.e., commander-in-chief of the armed forces). He already has been the president of the party school in Beijing
[4], where senior government officials are being educated. Since his administration there, the school has encouraged different thinking: such as the development of social democratic parties in Europe (Montesquieu: dividing the state in three ways: an executive, legislative, and judicial part).

Additionally, the implementation of direct elections for village chief proves that the Politburo wants to keep its population as pleased as possible. Mr Li – a Beijing-based researcher who observes rural politics – predicts that in ten years China can have directly elected mayors and maybe a directly elected president by 2020 [5].


Corruption now is far worse than it was in 1989, when it was one of the main causes of the anti-government protests. In Shenyang there was a huge scandal last year, linking many top officials with a local mafia gang. The deputy mayor was executed and the mayor sentenced to life in prison. Despite the inevitable corruption politically there is reason for optimism: provided that the GNP will continue to rise more than 7% each year. But what does the Chinese economy now look like, and is it realistic to assume that the economy can grow more than 7% each year?

Obviously, the large inflows of FDI in the past decades have helped the Chinese economy. The country also has a trade surplus, low short-term foreign debt and large inflows of foreign direct investment. Another bright spot is the rise of tourists into China. However, a recent study conducted by the OECD predicted that China's entry to the WTO could cause the country's current-account surplus to turn to deficit by the middle of this decade. But it said this would not pose a serious risk to China's (huge) foreign-exchange reserves.
Additionally – to keep its GDP growing – there was much government spending; causing a fast increase of government debt. Meanwhile, the vast amount of non-performing loans (NPL’s) in China continues to pose a major threat towards the future. Since banks in China simply have very low solvencies, they cannot provide loans to enterprises to improve their business performance. The official figure of these NPL’s is 25% of total outstanding loans, but the figure calculated by the Brookings Institution is 50%.

To add to the alarming debt problem in China, is the outstanding overall debt of the government. The official figure is 16% of GDP, but the Brookings Institution calculated it could be as much as 100% of GDP. Surprisingly enough, there is little chance of a banking crisis, simply because there are hardly any foreign banks’ branches anywhere in China.

The telecom industry and banking sector are the most protected areas of the Chinese economy. Interesting thing is that the Chinese currency – the Yuan – is not completely convertible. This means that Chinese are limited to do their banking business mainly with shaky domestic state-owned banks while at the same time foreign investors can hardly trade the currency (for instance on the two Chinese stock markets, Shenzen A and Shenzen B, are made up of inefficient state owned companies). I also would like to emphasize that to let the insecure pension funds survive – important to keep social welfare for the less privileged at a certain level, the stock market has to function like Western stock markets (in order to attract foreign institutional investors).

This brings me to another big question: does the Communist Party want foreigners to do business in China? The local government does not: they have too many personal interests in local (incompetent) state-owned enterprises and are afraid to lose control when they give companies too much freedom. I think China has to involve foreigners to let the GNP grow.
But how are the current relations with investors and the rest of the world?

CHINA AND THE REST OF THE WORLD
China is exporting much (from primary goods to electronics) and its quality is continually rising. Additionally, Yu Yongding, a senior economist at the Chinese Academy of Social Sciences, says: “one reason for the relatively buoyant exports is that consumers in Japan, the EU and US are tightening their belts and choosing cheaper products.”
[6]. In other words: China is becoming a local engine of economic growth.

China is already importing goods from the rest of Asia (some economists say China will soon replace the US as number one importer of Asian goods) and will continue to do so as long as the economy keeps on growing. For example, China’s emerging middle class imports high-end products from Korea (mobile phones) and Japan (cameras).

How can multinationals approach the Chinese market best? Let us take a look at the telecom industry now.

JOINT VENTURES?
With China's mobile-phone users increasing at a rate of about 5m a month last year and China Unicom, one of the two official cellular companies, rolling out a new US-standard Code Division Multiple Access (CDMA) network, the country is a market no telecom company can afford to ignore. "It's an exciting time - for the first time it is possible for foreign investors to go into China in a legally sound structure and form a joint venture," says Andrew McGinty, a managing associate at law firm Linklaters & Alliance in Shanghai
[7]. In the past foreign companies were forced to start a joint venture (JV) with a Chinese company. Nowadays, a joint stock company under Chinese law looks to be more interesting for a multinational. A number of multinationals have done this in recent years, most notably Unilever, Alcatel and Michelin. "The restructuring made the business manageable," says Alan Brown, who heads Unilever's operations in China. "So many people find that in JV relationships, their partner's wishes are not aligned and you can't really manage the businesses" [8].

Personally, I think China can deal with the problems mentioned in the chapter WTO ENTRY, provided that it is willing to cooperate with foreign institutions.

FOREIGN DIRECT INVESTMENT
Investing in China is interesting for multinational corporations, for the following reasons: cheap labor force, cheap real estate to build factories on, to seek partnerships with Chinese companies and huge consumer market (opened by the WTO).

Other arguments to invest in China could be: to be close to the customer. Another one is to establish a position now with the prospect of benefits in the future. Arguably, the most important one is that corporations are able to cut production costs globally while at the same time be competitive locally. China is now the world's fourth-largest industrial producer behind the US, Japan and Germany. China makes more than 50% of the world's cameras; 30% of its air-conditioners and televisions; 25% of its washing machines and nearly 20% of all refrigerators. For example, Philips formed a partnership with the Chinese company TCL. As a matter of fact, China became a place where the company made its products and then shipped them elsewhere. Today, Philips operates 23 factories and produces about $5 billion-worth of goods in China each year. [9]


On the other hand, exporting to China may be as cheap to produce locally due to the lowered trade barriers and quotas (WTO). According to a LG Electronics executive: “It has been suggested that directly exporting products to China may be even more profitable than producing them locally.” [10]
Additionally, Mr Laudicina (managing director of A.T. Kearney’s global business-policy council) says that: “In previous surveys of investors in China, the majority of companies were not meeting their profitability targets.” [11]

To make things even more complicated for foreign companies, the government itself is deeply involved in business. The Beijing municipality, for example, has stakes in about 16,000 local businesses. The finance ministry owns 100 per cent of the "big four" state banks. The telecommunications regulator is the main shareholder in China Telecom and China Mobile and the television regulator owns China Central Television, the state TV company. [12]


To come back to the telecom industry: can the joint stock company be a solution to the telecom restructuring in China and to boost employment and GDP? "Today you have the right in theory to own 25 per cent of a mobile network, but what does that mean when there are only two licensed mobile carriers, China Mobile and China Unicom?" says Duncan Clark, managing director of BDA (China), a telecom and internet consultancy.
Some operators, such as Pacific Century Cyberworks (PCCW), Hong Kong's telecommunications company, chose to stay out of the WTO-related skirmish altogether. PCCW is concentrating on providing corporate IT services to its clients in China rather than trying to compete with the national telecom companies. [13]


Even though private companies are successful, there is internal opposition of Chinese policymakers. So while the two national mobile phone carriers are heatedly competing each other (even sawing opponents’ cables, smashing equipment, and beating up their rival's staff
[14]), foreigners have prospects of steadily entering the Chinese market – to make listing on of healthy companies the stock market possible and so reinforce the Chinese economy.

CONCLUSION
I have confidence China will move gradually towards a more Western-like market economy. Even though private companies have many difficulties getting a listing on the Hong Kong or Shanghai stock market, they will continue to be successful. "Our most serious competitors," says Zeng Xiwen, Unilever's spokesman in China, "are private Chinese companies."
[15] However, there should be more action from the Politburo to initiate true reform. Also, multinational corporations should be given more freedom to operate in the vast Chinese market. But to be realistic – having studied Chinese civilization and its emperors (who since the Qin era have been autocratic rulers) – changing the Chinese bureaucracy will prove to be very difficult. While trade partners of China will keep importing Chinese goods, China will not collapse. Ideally, multinationals can do their manufacturing in China, but keep their marketing/branding and logistics at their headquarters (since they are high value adding and profitable).
Clearly, domestic companies cannot handle the massive unemployment alone, which is almost crippling the Chinese economy and Communist Party.

When actually negotiating with the Chinese, one also has to deal with cultural differences. According to Mr Clark – a consultant based in Beijing – on top of the unique Chinese (business) etiquette, there is also regional diversity.
[16] Bob Kapp (president of the US – China Business Council): “Be modest in demeanor. Listen well. Preach little. Watch how others do things and follow suit.”

[1] Chinese Ministry of Foreign Trade and Economic Cooperation 2002
[2] The Economist 13 Jun 2002
[3] Chang 2001
[4] The Economist 13 June 2002
[5] The Economist 13 June 2002
[6] Financial Times 15 March 2002
[7] Financial Times 15 March 2002
[8] Financial Times 15 March 2002
[9] Far Eastern Economic Review 17 October 2002
[10] Nikkei BP AsiaBizTech+Nikkei Electronics Asia, Online Magazine for Engineers and Managers, 2002, [China Special] LG Electronics Targets China's CDMA Handset Market [Online]
[11] Far Eastern Economic Review 10 October 2002
[12] Financial Times 15 March 2002
[13] Financial Times 15 March 2002
[14] The Economist 17 October 2002
[15] Far Eastern Economic Review 17 October 2002
[16] The New York Times, 3 May 2002

BIBLIOGRAPHY


  • China in the World Economy: the Domestic Policy Challenges”, OECD, Paris 2002;
  • Integrating China into the Global Economy”, by Nicholas R. Lardy, Brookings Institution Press, Washington, DC, 2002;
  • The China Dream: The Elusive Quest for the Greatest Untapped Market on Earth”, by Joe Studwell, Profile Books, London 2002.
  • Nikkei BP AsiaBizTech+Nikkei Electronics Asia, Online Magazine for Engineers and Managers, 2002, [China Special] LG Electronics Targets China's CDMA Handset Market [Online]
  • Burying the Competition; By Karby Leggett/SHANGHAI and Peter Wonacott/BEIJING
  • Issue cover-dated October 17, 2002; Far Eastern Economic Review
  • How to get a foothold in China; By Liz Alderman (IHT); Friday, September 6, 2002
  • China Dream; By Tom Holland/HONG KONG; Issue cover-dated October 10, 2002; Far Eastern Economic Review
  • ASIA'S WOES ARE NOT JUST CHINA; By Peter Wonacott; Issue cover-dated October 17, 2002; Far Eastern Economic Review
  • Philips Switches Tack in Hard Market; By Peter Wonacott; Issue cover-dated October 17, 2002; Far Eastern Economic Review
  • In China? Mind your hat By Craig S. Smith (The New York Times) Friday, May 3, 2002
  • A dragon out of puff; Jun 13th 2002 From The Economist print edition
  • Colour me grey; Jun 13th 2002 From The Economist print edition
  • Seeds of change?; Jun 13th 2002 From The Economist print edition
  • Money worries; Jun 13th 2002 From The Economist print edition
  • No rural idyll; Jun 13th 2002 From The Economist print edition
  • Drastic medicine; Jun 13th 2002 From The Economist print edition
  • Urban discontent; Jun 13th 2002 From The Economist print edition
  • Be prepared; Jun 13th 2002 From The Economist print edition
  • Dialling the markets; Oct 17th 2002 HONG KONG From The Economist print edition
  • Set them free; Oct 10th 2002 From The Economist print edition
  • Not in the club; Oct 10th 2002 HAICHENG From The Economist print edition
  • The Pearl river deltaA new workshop of the world; Oct 10th 2002 HONG KONG From The Economist print edition
  • INDUSTRIAL UNREST PROTESTS ILLUSTRATE THE FRAGILITY OF SOCIAL STABILITY IN SOME REGIONS AS CHINA STARTS TO IMPLEMENT ITS WTO COMMITMENTS Financial Times; Mar 20, 2002 By JAMES KYNGE
  • A lucrative new market is calling: TELECOMS by Joe Leahy: China's mobile-phone users increased at a rate of about 5m a month last year.
  • Foreign vendors are desperate to move in Financial Times; Mar 15, 2002 By JOE LEAHY
  • COMPANY TRENDS by Richard McGregor: The joint venture is being replaced as the modus operandi of foreigners in China
  • Financial Times; Mar 15, 2002 By RICHARD MCGREGOR
  • A crucial transition is ahead: ECONOMY by James Kynge: The challenge is to keep GDP growing fast enough to provide a cushion against the shocks that accession will bring
  • Financial Times; Mar 15, 2002 By JAMES KYNGE
  • Reform, but in a communist state: POLITICS by James Kynge: Although WTO accession will force the pace of change, a western-style democracy is unlikely in the near future Financial Times; Mar 15, 2002 By JAMES KYNGE
  • Expectations look set to outstrip the reality: BANKING by James Kynge Financial Times; Mar 15, 2002
  • Problems on the road to liberalisation: China has joined the WTO on stricter terms than fellow members. If it is to succeed in opening its markets, the world should resist using protectionist provisions Financial Times; Mar 15, 2002 By NICHOLAS LARDY

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