Chinese multinationals, finance, outsourcing, travel, politics, and trade vs challenges and conflicts under globalization

By Financial Sense

JIM PUPLAVA : My guest this week is George Zhibin Gu, author of two new books : 1. China’s global reach ; markets, multinationals, and globalization ; 2. China and the new world order : how entrepreneurship, globalization and borderless business are reshaping China and the world.

George, you grew up in China during a very difficult time, especially during the Cultural Revolution. How has this impacted your thinking today in terms of how you view China ?

GEORGE ZHIBIN GU, PHD : Well, while I was growing up in China, China experienced a cultural revolution, as well as people’s communes in the countryside. It was chaotic, it was characterized by abusive government power which was expanding into everybody’s lives. What is more, it was an entirely closed society. In other words, every citizen had to work for the government to make a living. So the government exactly demanded the servitude of citizens, but today everything has changed fundamentally. So, in my mind two things are most crucial for modern society and progress, that is, having an open society is a must ; secondly, private initiatives - people must rely upon their own efforts for progress and prosperity. That is exactly what has been happening for the last 25 years. This makes all the difference. The third one is that international participation in any country’s development is a necessity, otherwise development slows down tremendously. So, the situation in China and India shows [this is] the case. [3:05]

JIM : You know that was one of the points that you made in your book, that the grand lesson of China is that no nation can truly develop without making itself open to the rest of the world.

GEORGE : That is very true. 500 years ago, Europe became an open society expanding globally. Especially the US, it depended on talents, capital, and technology from the rest of the world. That’s why the US has become a dominating power globally for the last 100 years. Today, China is doing the same thing, relying upon all the resources from around the globe. [3:46]

JIM : You know, one of the great paradoxes as you look at China today is this vast economic progress, but it does not have a new political-economic system in place. Can you explain that ?

GEORGE : Basically, this current reform at an institutional level was initiated by the government. The government wanted to try something different from the previous 30 years. In Mao’s era the government dominated all economic and political spheres - everybody had to work for the government. On the other hand this political structure created a lot of burdens for the government. Therefore the government wanted to shift the burdensome aspects of the business to the society and people. At the same time, government does not like to give up on its traditional power hold on the society, therefore at the institutional level you [will] still see that traditional political framework is still at work. For example, about 70% of China’s business assets are still in government hands. So, this is one fundamental aspect of China’s current reform. However, you see the other trend which is overpowering the government and promoting its political and economic reform, reluctantly or not. [5:24]

JIM : George, in your mind what are the key driving forces behind China’s economic development today ?

GEORGE : Number one, opening up. During the Cultural Revolution, China’s economy was shutdown. It had no economic ties to the outside world whatsoever. So, opening up China has brought new ideas - technical and technology - as well as results, for growth. So, this is the most crucial aspect behind the growth.

Number two is the domestic consumption explosion. For example, 25 years ago China did not have any mobile phones, but today China has about 400 million mobile phone subscribers. Also, 20 years ago China had few television sets, but today almost every urban family has at least one television set, and in the countryside about 50% do. So, therefore China has become the biggest home appliances market really.

Number three is international involvement in 3 areas. The first area is foreign direct investment (FDI). In the last 26 years China has received more than 600 billion US dollars in FDI. This FDI has prompted new growth, especially in the manufacturing area. Number three is international trade. So far, China’s international trade has grown tremendously from next to nothing 25 years ago to one of the top three trading nations today. So, this international trade is another area of growth, but overall the domestic consumption explosion is the foundation. Without it China could not attract foreign capital or international trade. [7:33]

JIM : Now, you state in your book one of the ultimate goals for your country is to become a modern nation ruled by law.

GEORGE : That is true.

JIM : How does that happen given the government structure you have today ?

GEORGE : It’s actually slowly changing. The government has found out that it does not need to apply traditional power to rule over society. Actually, being without the law also brings burdens to the government. For example, in the economic field there are all kinds of disputes among different interest[ed] parties, therefore to resolve such disputes they must apply law, legal procedures in a new way. Therefore we have a lot of legal progress in the economic and business field. Even in the political sphere some new political measures have been introduced. For example, direct vote at the village level has been introduced. That is, at the village level the village leaders are directly elected by their villagers - that’s a new change. And if this trend grows you will see more political changes, especially in the legal and power structure. [8:56]

JIM : Most people would be surprised, even though China is referred to as a developing nation, throughout most of history China has been more advanced in technology, the arts, and social harmony. I wonder if you would give us a little historical background of just exactly how developed China was. I think most people would be really surprised.

GEORGE : For example, about 150 years ago China was the most advanced nation in terms of wealth. At that time, China contributed about 30% of world economic output. 1000 years ago China already had 50 of the biggest cities on a global basis. The biggest city in China at that time was Xian, which already at that time had a population of about 3 million. Also, about 50,000 foreign nationals lived in the city, mostly from Japan, Korea, and the Middle East. Xian was the beginning point for the Silk Road, international trade had Xian as its center. This was about 1000 years ago. [10:27]

JIM : You know, the old China was based around government and agriculture. You’re moving away from that, especially away from government domination. But, you know, the one thing that seems to me that China does, which you don’t see too much, when you think of planning in the future, your government and people there tend to think in decades. Is that how you see this unfolding, it’s something that’s going to take decades before we see a completely open market, a completely open financial system, and less government dominance ?

GEORGE : It’s happening faster than previously thought. For example, even now, international banks are allowed to buy major stakes in Chinese banks. Therefore we have seen a couple of big transactions already happen : one is Bank of America ; another is HSBC buying serious stakes in the top five Chinese banks. This has prompted what I would call a revolution in the Chinese banking system. That is, not only is international capital injected into Chinese banks, but also a lot of managers - we’re talking hundreds of international managers appointed by Bank of America and HSBC - managing Chinese banks on a daily basis. That’s a huge change.

Also, another tremendous change is the emergence of 40 million private entrepreneurs. 25 years ago it was a completely state sector, now we are talking about the state sector retreating to about 50% or less in terms of economic output. The state sector now only contributes about 30%, the rest is from the private sector and the international sector. In terms of industrial output, 2 years ago, International Inc. - as a group - contributed about 31%. That’s a huge market share, we’re talking about a 1/3 market share. So, this international presence, as well as the private sector in China, are altering the Chinese political and economic map - that’s something nobody expected before. [12:56]

JIM : It’s rather ironic as the West moves to more government control, and less freedom, China is moving in the opposite direction.

GEORGE : Right now, China is quickly adopting international practice and standards in all kinds of ways. The only problem is this old government structure which still tries to dominate in the traditional sense. So, institutional progress is [slow]. Other than that the society, the business community and international parties are changing the Chinese traditional life in big ways. So, that is happening really in big ways here. For example, in coastal China in many regions such as Zhejian province, and Jiangsu province neighboring Shanghai, the private sector takes over up to 70% of the local economies. So, government power is [receding] tremendously. [14:06]

JIM : Now, in your book you talk about what makes a lot of this possible today is the emergence of multinationals, which you describe as the modern-day Columbus’ and Magellans. And China, to the multinational company is really the world’s last frontier.

GEORGE : That is true. Right now, we have basically everybody in China from the multinational group. They are active in all aspects of the business sphere, especially autos. They dominate China’s auto market. They are also major players in the mobile phone business, in high tech, in semiconductors. For example, right now, about 20% of the global semiconductor market is in China. So, regardless of which US semiconductor shares you hold, you are investing in China already because 20% of the sales are to China. [15:13]

JIM : George, what makes China attractive to multinationals ?

GEORGE : Basically, there are several reasons. Number one, there is tremendous consumption growth, also better profit margins. Number three, there is a relaxed business environment and sometimes in very odd ways. For example, China does not have Western type labor unions, so employers have plenty of choices in terms of their power over their employee body. And employees don’t have any bargaining chips. That is also a factor. Another factor is the many incentives given by the government such as tax incentives and other privileges. And number three is quick growth for the multinationals which are already playing here, therefore they force their competition to come. For example, all the telecom manufacturing operators are in China. Last year, Nokia did about US$6.9 billion in business in China ; FedEx did even more, about $9 billion in sales in China. Then you also have a lot of other guys - their competition - also the new players coming in, especially in high tech. Therefore, all of them have become the most significant players in China. They have to be here, because right now up to 30% of their sales come from China, directly or indirectly. [17:06]

JIM : Now, in May of 2003 the Chinese government allowed 2 investment banks, Nomura and UBS to trade in the Chinese stock market. George is this a sign of things to come, and initially why only two companies ?

GEORGE : Basically, the Chinese government has a law qualifying foreign institutional investors to play in the domestic market. Initially, they gave about a US$4 billion allowance and you have to go through the selection process. So, in order to attract competition from foreign money managers so every month they gave permits to a couple of players, that’s how Nomura and UBS got the first tickets, but we’re seeing during the last year and a half about 27 UBS competitors such as Morgan Stanley, Goldman Sachs and JP Morgan all got [permission]. So far, they have invested about $4 billion, now they’re putting an additional $6 billion (US) into China’s domestic stock market. So, that’s what’s happening. [18:26]

JIM : I wonder if you might explain how the development of China has become the global manufacturing center has been more of, let’s say, a move by demand than by design.

GEORGE : Yes, that is one of the biggest Chinese growth stories, and nobody expected this to happen 25 years ago. It has come to life more by accident than by design. The initial stage was really a shift to meeting consumer demand for home appliances and electronics. At that time China did not have anything to manufacture on its own. It shared a lot of TV sets from Europe, Japan, and South Korea directly. But those TV sets had high price tags on them. You’re talking about the average Chinese family having to spend up to 10 years of their savings to buy a TV set. This huge profit margin prompted tremendous domestic investment. Immediately, we’re talking about several hundred Chinese TV manufacturers emerging by the mid 1980s. The same thing can be said of other areas of consumer products. The demand was tremendous, that’s because for most of the time China had a tremendous goods shortage for about 3 decades. There was nothing on the shelves. If you wanted to buy a pair of shoes you might have to wait or if you bought a bicycle you needed to find a friend to help you get one. So, there was a tremendous shortage meeting this huge consumer demand which therefore gave birth to the initial setting up of new manufacturing. Once this new manufacturing was set up, then they had to buy all sorts of components and chips. At that time, China couldn’t manufacture them itself, therefore it had to buy them from the overseas market, such as from Intel, Texas Instruments, and IBM, and Motorola. Therefore those international multinationals made huge profits sending their components and chips to China. Later they found out that they had better set up manufacturing facilities within China in order to make better profits. That’s initially how they came 25 years ago. So they were brought by the tremendous profit picture, and immediate business transactions.

Later on, Intel and Texas Instruments’ competition all rushed in. The same thing is true for all other economic sectors. So competition brought more and more multinationals to China. Of course, these multinationals have more economic muscle, they can manufacture almost anything, therefore they have helped to directly expand the growth of China as a manufacturing center. Later on, the Chinese [had] learned a lot from these multinationals, they started manufacturing key components and software and also chips. So, more competition was arriving from every party, but the market is still expanding, therefore the bigger pie is attracting more players to rush in. Therefore we see the emergence of China as a manufacturing center.

We’re also talking about other areas of improvement to facilitate this growth as a manufacturing center. Number one is infrastructure. So, China has become the number two energy market on a global basis. It has built the most power stations over the last 25 years, also roads, ports, as well as the service sector. For example, all the major global shipping companies and express companies are all in China. For example, Federal Express, UPS, and all their competitors are in China. Therefore, China through all such activities has gained all the key elements to build a major global manufacturing center. It came as an accident but by now, it has brought on a rush by everyone else behind. So we might expect a quicker development for services to add to this new manufacturing center. At this time, this manufacturing center is able to produce at low cost as well as efficiently almost all sorts of products, this is the biggest change for China’s economy, as well as for the global economy. [23:50]

JIM : George, there are other places in the world where the labor pool is much cheaper. For example, India and there are other countries. Is it China’s sense of business or its entrepreneurial shift which distinguishes China from the other places in the world ?

GEORGE : Yes, I would say that it’s China’s overall strength that makes China a new business center. If you compare India and China you will see that India’s labor market is cheaper - about 50% cheaper - than China’s. But India’s development is more in the service sector, especially for software consulting and outsourcing. But China’s manufacturing [has advantages over the] Indian one in many aspects. This is because China has built up a complete business chain, for example, India does not have an effective manufacturing base at all. It lacks key component suppliers, it does not have the logistics, it does not have the infrastructure, but China, over the last 26 years has gotten all of them in one place. For example, in consumer electronics you can set up your shop in Guangdong, then you get more than 10,000 component makers. For example, Sony alone has more than [3,000] China based component makers. Here, you need to know that these component makers come from both Chinese companies and multinationals. So, Sony’s 3,000 come from the Chinese, the Japanese, Koreans and Europeans, and American suppliers, always in China - actually, in one province. That’s the kind of effectiveness and efficiency China has, but in India, and even in Europe you don’t have that kind of advantage.

Another advantage is the low price [gap]. These companies rely on cheap labor as well as mass production which can give you the best price, and also delivery at the best time, or any time. Therefore it gives Chinese manufacturing a lot of advantages. This is something India, and many other countries, don’t have. To build up this we are talking maybe about a trillion dollar investment plus all the key players - we’re talking about tens of thousands there from all business sectors. That’s difficult to attract all the elements into one place, within such a short time. Therefore, I call this Chinese manufacturing center an accident rather design. But it is now entering a new phase - with a lot of powerful players and a lot of design coming into play. [27:06]

... For complete transcript, see www.financialsense.com/transcriptions/2006/0114Gu.html