Fundamentally, China embarked on a capital driven economic expansion
guided by flooding the global market with everything the world needs
without having to sweat capital costs or the costs of sourcing
capital. Why it works of course is that the internal Chinese market
also kicked in to allow massive production runs which drove even
marginal costs down.
All well and good so long as you never sweat the word profit which
becomes critical if you must access private money.
The problem facing China now is that the working population is now
fully engaged and rising costs reflect this. They also must make the
transition to new product creation and the inherent risks there.
This happened to Japan in 1990. China is just ten times larger.
Of course such an expansion regime opens the door wide for
corruption. It is China's great fortune that society is comfortable
with that and the recipients actually are remarkably responsible.
Even runaway capital rarely brings the source itself as he is
obligated to work there.
The problem will begin in earnest when it becomes necessary to access
public capital just to sponge up the surplus. That has already begun
to happen with the building booms going bust as hot money spins
around looking for a home.
Count the trucks.
The China
Information Conundrum
Sunday, 09 December
2012 07:50By Charles Humphrey
With President Obama's
re-election sealed, he faces an intimidating number of challenges
both at home and abroad. One problem in particular, while it is
overshadowed by domestic economic concerns, nonetheless deserves the
administration's full attention if the United States is to solve its
domestic and international challenges of the next four years and
beyond. That problem is China and its rogue administration. The
reality is that the world faces a problem in China that is both of
crucial importance and very difficult to discuss. This problem is the
impossibility of obtaining clear, reliable information on the
country's political, social and economic situation. In the West,
there are normatively high standards required for mainstream
journalists in terms of sourcing and fact checking. When these
standards are applied to a political system whose survival and
function depends on a tightly controlled information economy, it
makes for a gaping chasm between the global perception of China and
the realities on the ground. This is a matter that should be of
concern to private investors, policymakers and the growing number of
people around the world whose personal and professional lives may
become increasingly tied up with China.
To be sure, there are
exceptions to this rule, but their nature only proves the point.
There are a number of firsthand personal accounts in print and the
Internet which, to the discerning reader, give a glimpse into the
deeper reality of what is going on behind the Chinese Communist
Party's (CCP) one-way mirror. Most notable is the August
2012 Prospect article by Mark Kitto entitled "You'll
Never Be Chinese" documenting one man's decision to leave China
after years dealing with a corrupt court system (to call it a "legal"
or "justice" system would be inaccurate) and widespread
insecurity, uncertainty and overall frustration. Kitto's account is
exceptional in that by basing his business in China, he more directly
experienced the difficulties and dangers of operating there than the
average outside investor, but his story is not unique in and of
itself. The 'net is rife with blogs and posts from on-the-ground
expats who live in such a way that brings them into direct contact
with the reality of life in China. For all the effort of such
individuals, the marginal place of such information in the larger
infostream, and the way in which it can be dismissed as mere
subjective griping, affords them little power in shaping mainstream
debate and perceptions.
Despite the
proliferation of alternative media, the world still relies heavily on
the mainstream media for a reliable picture of the world. There are
good reasons for this. The reputation, resources and accountability
of a major media organization provide for the possibility of greater
depth, breadth and accuracy that all the bloggers and tweeters in the
world cannot hope to replicate. Say what you will, #BobinBeijing is
not likely to be as reliable as BBC World, whatever biases may come
into play for mainstream outlets.
To be fair to the
mainstream media in China, there are exceptions, the most notable
being Al Jazeera's Melissa Chan, who did exceptional reporting
highlighting the overwhelmingly dark side of life in China. Her
writing was broad and in-depth, covering forced abortions, black
jails and powerful gangs, as well as a piece specifically on the
dangers she ran from police and hired thugs when trying to interview
common Chinese about their problems. Chan was exceptional in that
what happened to her demonstrated how little actual reporting gets
done by other mainstream journalists. She did real journalism, and
was expelled for it.
The logical conclusion
is that reporters still remaining in China are careful and tactful
enough about not ticking off the CCP that they are allowed to stay.
The impact such a situation has on our ability to obtain in-depth and
reliable information from China is obvious. It is hard enough to get
a clear picture in a country as vast, complicated and politically
unstable as China, but it is downright impossible when the interests
of continuing one's career in that country make one unwilling to even
try. That Chan was made to leave while a large number of foreign
correspondents remain indicates that this enforced apathy may well be
the status quo amongst those reporting in China.
Beyond the failure of
mainstream media to work effectively in China, there is a further
problem in China information. This problem is slightly less concrete,
but perhaps more important in a world where financial metrics come to
determine a great number of decisions. It simply doesn't make sense
to put any faith in metrics which were developed by and for Western
societies in the China context. In my opinion and that of many of
those who have spent considerable time here, China's apparent rise
is largely due to the CCP's ability to play with metrics in a way
that more transparent governments are not. A number of factors play
into this situation.
At the heart of it is
a general lack of accountability at the top, which then trickles down
to every segment of society. Something that anyone who has never
lived in China cannot appreciate is the extent to which rule of law
is absent. The very notion of rule of law as understood in most
developed societies is impossible in a system such as China's. For
law to exist requires some recourse to redress open to all members of
society. When a governing body is composed of a political
organization which by its power and constitution is unaccountable to
the rest of society, then law in itself is impossible beyond a mere
external charade of court rooms and costumes. This was clearly
illustrated in Kitto's story of being told he had "won" a
case, only to later be told that in fact, owing to a phone call to
the judge by someone in power, he had "lost."
This plays out in a
number of unfortunate ways in the lives of common Chinese people, and
this fact has occasionally been documented. But more unsettling in a
global context is what this means for the reliability of Chinese
metrics. If there is no law, then there can be no effective
regulatory enforcement of even the barest accounting standards. There
is simply no way to enforce any kind of regulatory standards on
Chinese businesses or government agencies owing to the particularity
of China's system. Not only is this an immediate problem for
verifying reports, but it creates a growing and persistent rot in
undermining any culture of accountability. If positive numbers mean
success and respect, and there is no effective means of ensuring
accuracy, then the onus falls on accountants working in Chinese
organizations to find every way they can to inflate numbers and
create false perceptions. This is already a danger in a culture where
direct communication is often taboo, but the combination of a lack
of clear regulatory enforcement and the culture this generates within
organizations, repeated across a country of 1.3 billion, creates the
potential for a proliferation of massive, self-perpetuating metric
bubbles.
The consequences this
can have for investors outside China was made clear in the case of
Sinoforest, a Yunnan-based forestry company which at one point was
the highest-valued resource stock on Canada's Toronto Stock Exchange
but which turned out to have none of the physical or liquid assets it
reported and whose head office was in fact nonexistent. Sinoforest is
exceptional not in itself but in the fact that it was exposed. Anyone
with serious on-the-ground experience and a good analytical mind
knows that the Chinese market is full of such companies waiting to be
outed. Many of them never will be.
A less extreme
example, but one which is very illustrative of the problems for
outsiders understanding China is captured in a 2011 interview
in McKinsey Quarterly with China International Marine
Containers (CIMC) President Mai Boliang. The opening paragraph
glorifies CIMC's growth in much the same glowing way that marks much
China business reporting, stating how, "20 years ago [CIMC] was
a small, little-known container manufacturer with just 59 employees.
Since then, under the leadership of Mai Boliang, the company has
become the industry's global leader."
This all sounds fine
in itself; companies grow, and very small companies, if well run, can
become global leaders. McKinsey points to "aggressive domestic
and global M&A [mergers and acquisitions] program ... and a
relentless push to innovate and to disrupt the status quo" as
the explanation for CIMC's growth. Now, to a Western reader, this
gives a certain image based on a legacy of successful business
innovators. The mistake that ends up being made when dealing with
Chinese businesses is to assume that these reasons mean the same
thing in China as in a reader's country of origin. In many
industrialized countries outside of China, this type of success story
means that a business, operating on a relatively level playing field,
was able to fairly outperform competitors. This trajectory indicates
sound business fundamentals and solid leadership. What about inside
China? Naturally, Mai was playing to his audience and telling them
what organizations like McKinsey expect to hear - the story of
innovation, competition and hard work. The reality of CIMC's rise is
apparent in some of Mai's comments on CIMC's early days, as well as
on his CV.
The logic of this
analysis risks being lost on anyone who doesn't understand the
workings of Chinese society and the business-government nexus which
lies at its core. For insiders, it doesn't take long reading
the McKinsey article to see what's going on. Note first
that CIMC is a state-owned enterprise, officially an organ of the
government. This is important for what comes next. While Mai indulges
his ego in the interview by suggesting it was his vision, hard
work and intelligence that allowed the company to grow, it's
important to note the casual remark that when Mai took over, the
supposedly cash-poor company "signed agreements with other
manufacturing companies under which we operated their businesses,
paid them lease fees for the opportunity, and pocketed whatever was
left over."
Mai has couched this
in civilized language, but this amounts to an effective government
expropriation with compensation which was obviously below the returns
generated by the expropriated businesses. That a successful
manufacturer would allow CIMC to operate their business for a lease
fee that was below their expected profits, allowing CIMC to "pocket
the difference" would be unthinkable outside the context of an
unaccountable state-owned enterprise (SOE) with a mandate to expand.
Unfortunately, Mai's bio is not available on Chinavitae, but based on
his meteoric rise from obtaining a BS in mechanical engineering in
1982 to president of CIMC in 1992 at the age of 33, and then on to
effective expropriation of China's coastal container manufacturing
industry, I would bet my meager savings that his father is a senior
government official.
This would mean that
the rise of CIMC is not in any way due to the usual combination of
thrift and innovation that is required in a level playing field, but
instead would be due to the overwhelming power of Mai's family
connections. The corollary of this possibility is that CIMC's
continued success does not hinge upon the continued effort of its
leadership, but on the political fortunes of its government backers.
This point is particularly salient given the power transition coming
up this fall. Politics and business are always tied in some manner,
but in China, the two are inseparable in a way that is hard for
outside observers to fathom. The leaps involved in this deduction are
again not apparent to anyone who has not lived and worked with normal
Chinese people who are not connected to the government, but it is
based on fundamental social realities of life in China. This
illustrates the problem that the basic logic upon which outside
observers of China base their judgments on the country is foreign to
the Chinese situation.
The trends outlined in
this article are part of a worrying set of phenomena which will
puzzle governments and investors in the coming decade. For better or
for worse, China's rise is a reality no one can avoid. However, the
combination of effective interdiction of investigation by outside
media, the difficulties of obtaining reliable metrics, and the
different logic required in a society where business and government
are one and the same and are run by a single overarching organization
in the CCP make sound China strategies next to impossible for even
the shrewdest analyst. This is a problem of which too few
observers and investors are aware and one which distorts global
perception and response to China, much to the benefit of China's
ruling CCP and the detriment of non-Chinese investors and
governments.
In response to this,
it seems essential that in the absence of reliable traditional
sources, those whose dealings involve significant China exposure
round out their picture with less traditional sources of information.
While the accountability of major media outlets and the ease of
analysis of financial metrics are obviously desirable, they are not
tenable in the China case. A true understanding of the Chinese
situation requires a messier, fuzzier information-gathering approach,
one which intersperses mainstream accounts and metrics with the
subjective details of various on-the-ground observers. Beyond
these, there are some good online tools which give a view into
Chinese media, the most notable being chinaSMACK, a site which
translates stories from Chinese online news and social media, along
with comments, into English. Many writers are fond of saying that
China is changing the game, but in order to respond to this fact,
those wishing to operate in China must change their game, too. This
starts with a heavily critical attitude toward the information that
the CCP is broadcasting out and a willingness to explore the
uncertain territory of a plethora of alternative accounts which
provide much needed context and nuance to the current narrative
coming out of the Middle Kingdom.
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