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Monday, September 22, 2003

Banking Reform Moves Forward

There is some evidence that the process of sorting out the Chinese non-performing loan problem is moving forward: slowly. Six billion out of a possible total of anywhere up to 750 billion dollars doesn't seem like a revolution. Still it is a start.

Chinese financial institutions plan to put up for sale about $6bn in non-performing assets over the next few months, marking the biggest push since 1999 to clean up the bad debts of the country's huge but insolvent big four state banks, Chinese officials and financial industry executives said. The new level of activism in China's most pressing economic reform signals an increased willingness from the government of Wen Jiabao, the premier, to experiment with new and different forms of asset disposal. It also suggests a potential bonanza for foreign and domestic investment banks. The big four banks, which between them have problem loans estimated at between $375bn and $750bn, are in a race to clean up their balance sheets and win official approval for a stock market listing.

The two front-runners to be listed are the China Construction Bank and the Bank of China, followed by the Industrial and Commercial Bank of China and, in a distant fourth place, the Agricultural Bank. The first move is expected to be an auction by Huarong, the biggest of four asset management companies set up in 1999 to dispose of about Rmb1,400bn in non-performing loans transferred from the big four banks. The auction, expected to take place this year, would be for NPLs with a face value of about $2.2bn, executives said. Yang Kaisheng, Huarong's president, started a roadshow to promote the NPLs to financial institutions in the US and Japan over the weekend. If it materialises, the auction would be only the second to be held since 1999, when a consortium led by Morgan Stanley bought NPLs with a face value of Rmb10.8bn and a Goldman Sachs consortium bought assets with a face value of Rmb1.97bn.

The increased size of Huarong's second auction indicates Mr Yang's confidence that foreign banks have been able to profitably dispose of the NPLs they bought. Mr Yang is also hoping for higher returns than in the first auction, when NPLs were sold for 8-9 per cent of their face value, Huarong executives said. Later, the Wuhan branch of Huarong plans to package about $500m in bad assets for sale, Chinese officials said. This represents a new method of disposal - previously only the head offices of the asset management companies were allowed to court foreign clients. Wuhan is an industrial city in central China.

Another new form of asset disposal is planned by the Bank of China in Hong Kong, which hopes to offer to the market assets with a face value of about $1.2bn, executives said. Because Chinese banks are not allowed to sell NPLs directly, the Bank of China assets are being packaged and held by a Cayman Islands entity, said the executives, who declined to be identified. It was not clear if the Bank of China (Hong Kong) plans have received approval from Beijing. A spokesman at the People's Bank of China, the central bank, said he had not heard of the scheme.China's largest bank, the Industrial and Commercial Bank of China, is also trying to package about $2bn to $2.5bn in non-performing assets for sale in the more distant future. The timetable for this sale was not clear.
Source: Financial Times

China's Real Munfacturing Revolution

Here's a nice piece for a change from the WSJ, and as they say, it's 'fair and balanced'. The message seems to be that there are scale and 'learning by doing' components to working in China, which is what theory would lead you to expect. Supply chain reliability and local management expertise are things which will only develop with time. This is really the strongest, and the only really uncontroversial globalisation argument. The third world isn't going to 'bootstrap up' if it doesn't have the opportunity to learn. Of course, once they start, then they become potential competitors, and we get to hear another set of arguments.

The argument about plant design is interesting, since having a high labour component is only a temporary option for China: with time wages and living standards will rise. Of course if they also manufacture capital goods there, then this will keep capital cheaper, and if a large part of capital costs are in IT hardware and software, and these come from China and India, then where we are going is anybody's guess. (BTW, thanks to Walter for drawing this article to my attention).

The Real Contest Between America and China

Shopping at Wal-Mart will give you the wrong idea about where China's threat to U.S. manufacturing lies. Most made-in-China consumer goods on those shelves represent industries which left the U.S. for Mexico and Southeast Asia years ago. Instead the real contest between American and Chinese factories is taking shape over industrial goods, a $2 trillion market of everything from small motors to oscilloscopes to locomotives, where fast-moving U.S. productivity and technology have kept production at home.

The problem is that China's rapidly-growing capability and huge scale are turning these U.S. defenses on their head, creating astonishing cost advantages in moving to China. These can amount to savings of 20-35% with no loss of quality -- opening the doors to moving even high-performance, highly-automated product lines there.

Unlike Japan a generation ago, which reinvented manufacturing through quality and continuous improvement, China is deinventing it by removing capital and reintroducing manual skill and handling on the plant floor. China's far lower cost of not only production workers but plant technicians, accountants and managers allows U.S. companies to rethink everything from how the product and its parts are designed to how they are made and tested.

The result is more craft, less complexity in plant processes, and often a shorter time from design to production -- all at a far lower total cost. Together with the improving quality of materials and reliability of supply chains inside China, this means some American companies are moving whole core product lines there.

But many are not. China is still small fry in the U.S. industrial-goods market. Domestic production accounts for 70% of industrial goods sold, and imports from Japan and Western Europe account for another 20%. Only 10% comes from low-wage economies, and China has less than one-third of this -- or 3% total penetration of the U.S. market, shipping fewer goods than Mexico.

Many American companies find China's cost advantage elusive. Sending buying teams to China from their headquarters in the U.S., armed with drawings and specs in search of lower-cost sources, often doesn't work -- as American auto companies have recently learned. Small engine and low-end farm equipment producers, among others, have looked at taking production lines to China and found uneven quality and unreliable supply lines back to their U.S. customers outweigh the advantage of lower production costs. The higher technical- and inventory-support costs plus all the risks just aren't worth it.

Sourcing in China works best for companies which invest know-how and painfully nurture their China operations over sustained periods, and only a limited number of foreigner manufacturers have done this so far. Our research shows that companies committed to large-scale manufacturing in China think differently in several important ways from competitors without such commitments.

First, committed companies accurately cost the labor and capital costs of their products. Accounting statements may tell a finished-equipment manufacturer that factory payroll is only 10% of its costs, but when the full payroll cost of the purchased components and company overheads are added in, the total labor costs are typically 40% to 60% of the final product cost. And those labor costs are lower across the board in China. Production workers typically cost 5% of their U.S. counterparts, while good engineers and plant managers may cost 35%.

But what about higher U.S. labor productivity? True, American workers in capital-intensive factories can be several times more productive than their Chinese counterparts. That's because U.S. plants have replaced many factory workers with complex flexible-automation and material-handling systems. This has reduced labor costs but raised capital and support systems' costs.

Chinese factories reverse this process by taking capital out of the production process and reintroducing a greater role for labor. Parts are designed to be made, handled and assembled manually. This reduces the total capital required by as much as one-third. So output per worker is lower in Chinese factories, but the combination of lower wages and less capital typically raises the return on capital above U.S. factory levels.

American companies like Kodak or Copeland that develop several factories in China will see more cost savings than a competitor taking its first steps. Several factors working together explain this. These companies develop and improve their local suppliers. Their Chinese engineers learn the quality disciplines. And they become smarter in hiring people and designing incentives. The costs and benefits of manufacturing in China increase with scale and experience there, meaning that the more you grow the easier it is to continue to grow.

Second and counterintuitively, it usually makes more sense to send a distinctive new product line to China than an old, price-pressured one. The payoff from sending the latter to China is low. The many one-time expenses -- product and process redesign, new local suppliers to sort out, and the need to requalify the finished product with U.S. customers -- could wipe out any profit margin. But designing a new product for China makes sense for a company well down its experience curve there.

For instance, Tektronix's new oscilloscope was designed by U.S.-based engineers working virtually with their China-based tooling counterparts. Although some materials and components were imported, the product will have only one set of start-up costs and a lower capital investment to amortize.

Third, companies committed to production in China take a more realistic view of the risks involved. Supply-chain risks are often exaggerated by outsiders. As for country risk, again China's resilience and production security tend to look better to insiders. That was recently demonstrated when the outbreak of severe acute respiratory syndrome earlier this year caused few supply disruptions from China. And Chinese authorities regard foreign-owned plants as valuable assets not to be disturbed.

But some risks are not exaggerated, such as the need to protect intellectual-property rights, which deters many companies from bringing highly proprietary processes to China. Armstrong, the world's leading floor- and ceiling-tile manufacturer, keeps some material formulas and processes in the U.S. AMP, the world's leading connector producer, had no choice but to move to China because of the cost savings involved. So its proprietary inline plating process in China is done in a special secure enclosure with specially licensed employees. U.S. auto companies know their technology is leaking to Chinese joint-venture partners, but in return they get a head start in China's exploding market.

There are limits to what can move to China. Products where customer-driven innovation is frequent and critical will not go. Nor will those where customization and intimate user contact with the factory are required. Some American customers, especially publicly funded organizations, will insist on goods being produced in the U.S. The most persuasive barriers to movement will be customer-related, not technology-related. Production technology is often surprisingly mobile and divisible between locations. Large portions of leading-edge medical diagnostic equipment are being made in China, and jet aircraft engines will follow.

While China today has only 3% of the U.S. industrial goods business, its shipments are growing at 21% annually in a basically flat market. This penetration rate will be governed by the rise of capability of foreign-owned and operated plants in China, not by wage increases or exchange-rate revaluations. The cost differences are too great. In addition, China is becoming the world's largest market for some industrial goods, for example machine tools and power equipment. There are many reasons to make more things in China. As more companies discover this, the impact on American jobs will grow, making it an increasingly potent political issue.
Source: Wall Street Journal

The Risks of Not Outsourcing

This piece tells us I think why the US would be ill advised to get involved in a trade war with China. Maybe such an eventuality would be good for the textile business back home. But for the companies in the technology sector, lack of Chinese outsourcing would only make them less, not more competitive with respect to their principal rivals.

Samsung Electronics, the world's top memory chip maker, said on Friday it would move most of its personal computer manufacturing operations in South Korea to China by 2005. This move is intended to increase its competitiveness against global rivals, such as Hewlett-Packard and Dell.

The transfer is the latest in a series of similar moves by Korean companies eager to exploit China's low labour costs and avoid industrial unrest at home, a trend that has heightened fears the country's manufacturing base is being hollowed out at a time when it is trying to recover from recession. "This is a global trend. If we produce and sell our products abroad, that will save our costs," a Samsung spokesman said. The PC business accounts for about 16 per cent of sales at Samsung's digital media division, which in turn contributes about a fifth of the group's total sales. Around 60 per cent of Samsung's home appliances and more than two thirds of its digital media products including PC monitors are already produced abroad. Under the transfer plan, Samsung's PC factory in Suzhou, China, which began operations in April, will become the group's main PC manufacturing base by 2005 with an annual production capacity of 1m units. Currently, 75 per cent of Samsung's PCs are sold domestically and the remainder abroad.
Source: Financial Times

It's Not the Economy, Stupid

Again I know it's being indulgent, but I can't resist it. Fons Tuinstra in Shanghai, with an advance posting of his WTO ChinaBiz column, being his very own ironic self. I agree, ridicule is effective. (incidentally, one argument no-one seems to be making, does occur to me. When Argentina pegged to the dollar, no-one complained, at least no-one on Wall Street. It may have been a good or a bad decision - I think it was a bad decision - but no-one cried 'foul'. Why was it thought a good thing for Argentina to peg: to create an infrastructure with financial stability. And why do some think it is convenient that China continue, for the time being, with the peg.........

Shanghai – China seems to be a convenient subject during the campaigns for American presidential elections, and at least two days afterwards. Especially in the upcoming campaign, since there are so many real issues politicians want to avoid – Iraq, taxation - China has become an issue very early in the struggle.

Unfortunately this time a real non-issue has the honor of becoming the epicenter of public attention in the US: the question whether China treats the world unfairly by pegging its renminbi to the US dollar. Even a Wall Street Journal commentator – not really a medium for China fellow travelers – sighted yesterday that since it is politics, arguments do not make a difference anymore. China has already sent US Treasury Secretary John Snow home, polite but empty-handed. Snow will have another go at this weekend’s G7 meeting, but that will not make much of a difference.
It is comparable to the Japan discussion the US in the 1980s when US manufacturers campaigned against Japanese cars. Now half of the Americans drive a Japanese car.

The US manufacturers, followed by lawmakers and the US administration accuse China of stealing American jobs in an unfair way. Other countries like Mexico and Italy lose many more jobs to China, but they have been less vocal on this issue. On the contrary, it is remarkable how many experts, countries and institutions agree with China when it says it first has to make its banking system healthy before it can give the renminbi in the hands of the free market.
Almost everybody agrees with China. The European Bank. The IMF. Nobel-prize winner Stiglitz. The Japanese Prime Minister. Mister Forbes. Almost nobody with a basic knowledge of economics thinks it is a good idea for China to float its currency, it might even hurt the world economy.

It is obvious that only a good alternative subject is going to take the heat off China. What advice can we give the American politicians? I think first they should turn away from the economy. It is very hard to blame anybody else for the fact you are unable to compete on a global market. Better forget about the economy as an issue unless you would really have a very smart idea to save it.

Just pick a little country with loads of nasty anti-American habits, and bomb the hell out of them – verbally please, not like in Iraq. If you promise not to send your marines, I can give you some really good arguments why you should take on Holland, my home country. We despise the US policy toward Iraq. We let homosexuals marry! You need more arguments? We condone soft drugs and legalized prostitution (although we liked it more when it was still illegal). We attract loads of American tourists who do not spend their money doing things that are banned at home. We facilitate abortion. We support safe sex. Economy is anyway such a boring subject is you have no really smart solutions. How can you keep up momentum for the next 14 months, especially if you still need a lot of favors from China? Go for the small countries and juicy subjects: that is much more convenient.
Source: The China Trade

Big Trouble Over Little China

With US elections looming next year, the volume in the war of words over the 'china trade' is definitely going up. Let's hope that's all it is, a war of words. I, of course, do not mean to imply that all China's trade practices are 'fair', nor would I suggest that such a thing could be said whilst keeping a straight face of the US record. What is more significant is the evident deterioration in the atmosphere. As I noted yesterday in connection with another topic , shouting normally is not the best way to make progress on an agenda. If this continues it is less, rather than more likely that the Renminbi will float any time soon. And following so close on the heals of Cancun, it has to raise a question mark over the continuing future of the globalisation process. No bad thing, some might say, but this would not be my view.

Chinese trade officials and experts reacted yesterday with a mixture of defiance and foreboding to several criticisms of Beijing by Donald Evans, US commerce secretary, that signalled a sharp increase in trade tensions across the Pacific.

Sun Huaibin, director of the China National Textile Industry Council, a powerful government-linked body, dismissed Mr Evans's complaint that China was pursuing "unfair" trade policies in some areas. "The US is always bragging about being a free-market economy," Mr Sun said in an interview. "Our competitive edge [in textiles] is the result of 10 years of reform and restructuring. The US textile industry should learn from our experience rather than seeking the help of their government."

The textiles sector is particularly sensitive in a bilateral trade relationship that has become a key issue for the next US presidential election. Mr Evans said the US administration was creating an "unfair trade practices team" to combat illegal product-dumping, intellectual property theft and other abuses by trading partners - mainly China - that contributed to a loss in US jobs.

US business groups also stepped up pressure yesterday, saying that China's compliance with its obligations under the World Trade Organisation had been "uneven and incomplete" and warning there could be "political consequences" if US companies did not see tangible new opportunities.

The toughly worded report from the US Chamber of Commerce, the largest business federation in the country, says China's entry into the WTO has raised the expectations of US companies, who want to see sales in China grow markedly.

"Without tangible improvements, there will be political consequences as well as a possible souring of business views about the market," it says.

The complaints that US companies are not winning sufficient business in China echo many of the charges made against Japan two decades ago when that country was running record trade surpluses with the US. But while the US in the 1980s negotiated a series of agreements to limit Japan's exports to the US, such mechanisms are no longer allowed under WTO rules.

China's trade surplus overtook that of Japan for the first time last year to total $103bn (€92bn, £65bn), raising widespread concern in the US that China is keeping its currency pegged at an artificially competitive rate. US calls for a revaluation have been rejected by China, although Beijing is considering moving to a more flexible exchange rate.

US Chamber officials said yesterday that they did not want concerns over China's WTO compliance to become an excuse for protecting the US market. They sought to distance themselves from the campaign launched by some US manufacturers and sympathetic members of Congress to press China into revaluing its currency.

"We do support engagement," said Joe Damond, a lobbyist for the pharmaceutical industry and member of the Chamber's China task force. "What we want to see is that engagement turn into concrete results for our companies."

China Watching and China Bashing

I'm trying to put together some thoughts on why I don't agree with the 'China is Going to Crash' school of thought. So reading around I came across this interview with the Ford Foundation Representative in China, Andrew Watson in China Development Brief (thanks to T-Salon for the link). The points Andrew makes sum up many of my feelings. China is a complex society, and China is changing. In the same way you can't take GWB and his 'republican guard' as the last word on the US today, it would be a mistake to say China is run by the CCP, period. The devil, as always, is in the detail.

...........in any society each individual performs a variety of social functions regardless of where their work assignment is and some of the most creative researchers and thinkers who've had the greatest impact on, shall we say, economic reform and development, have been in government institutions and quite often their role there enables them to have quite a big impact.

There's clearly a growing diversity of perspectives in China on the whole range of social issues and that reflects the increasing diversity and complexity of Chinese society. Even in areas which were not broadly worked on in society at large — say, international relations — there's a growing difference of perspectives on what is China's strategic interest, what kind of policy China should have towards particular current issues, and this is reflected in the growth of different kinds of institutions that now work on international affairs and foreign policy. In the 1970s that was essentially the preserve of the Ministry of Foreign Affairs but now you have — I don't know if you'd call them NGOS, but consultancy groups or independent groups working on international relations issues and producing research reports for provincial governments or companies related to issues that are going to impact on those particular groups. In economic affairs there's a lot of that as well, you have groups like Unirule and Horizon who are no longer part of a formal government structure and can act like independent consulting think-tank groups, and some of those have quite reasonable research capacity.

Many of the emerging types of social organisations are not yet institutionally mature enough or well established enough to be able to run solid research programmes in the area in which they work.................I tend to be relatively optimistic about the prospect for growth and change here. I'm not one of the 'China crashes tomorrow' school. I think there are clearly very significant issues to be sorted out. I'd like to see first of all a reduction in disparities in income, particularly between town and countryside and different regions; secondly, a greater provision of public goods and public welfare more broadly across China - urban areas still get a lion's share of these things and it seems to me increasingly important for the Chinese state to provide educational and health and other opportunities for rural citizens, and I think that's a really important challenge facing the society.............

To date, the reform and growth process in China has been basically driven from above. It's changes in government policy and experiments and innovation from within the system that has opened up the space for reform and change. The whole thing started off with rural reforms. Essentially the leadership took the decision that there could be contracting of land to the household, that the household could then use its labour appropriately, that there could be markets for goods that were not part of the Plan. And in fact those three changes opened up space in which peasant farmers and households were able to move their resources in all kinds of different directions, which helped change the structure of the economy, opened out all kinds of new types of rural activities, transformed the structure of agricultural production and so on. So policy change from above has a very important impact on what happens.

China: At Last the Voice of Reason

Phew, what a relief. I've spent half the week arguing with people who believe the China growth phenomenon is 'pure hype' (I will post on this tomorrow). Suddenly comes the voice of reality. Thank god for Andy Xie, giving us some facts about China:

Several US congressmen are reportedly proposing legislation that would impose punitive tariffs on Chinese imports.

In the media reports, one reads “unfair”, “illegal”, “manipulation”, “deception”, and “out-of-control” in quotes from politicians on Capitol Hill describing China. Indeed, it appears that those whipping up negative sentiment know how easy the old prejudices against China could be rekindled. But, strangely, the indignant congressmen are not smashing Chinese products on the Hill for TV cameras. I can still recollect the vivid images of the US congressmen smashing made-in-Japan tape recorders in the mid-1980s. This is the clue why I believe the furore on the Hill will not lead to any substantive measures.

China’s development model shares its upside with everyone who can contribute. More than US$500 billion in foreign direct investment has flowed into China. The supply chain from an industrial park in Suzhou to a hypermart in Chicago, for example, is full of different participants from all over the world. A Singapore company may own the real estate. A Hong Kong company may own and manage the factories. A Japanese company may supply the equipment. A US brand owner may design, brand, and import the products from China. A Korean shipping company may take the goods to the US. A US chain store may arrange the logistics and retail to the consumers in Chicago. “Made in China” is fundamentally different from “Made in Japan”. Japan’s keiretsu system kept the value chain for export production among Japanese businesses. The value chain for China’s export production is spread across the globe. Most of value added in China trade actually goes to Americans and other countries.

For each dollar of China’s exports to the US, American businesses add on about four dollars in value before the goods reach the US consumers. My estimate is based on the disclosed information from export companies listed in Hong Kong or Taiwan. China’s exports to the US, according to US government statistics, reached US$125 billion last year and grew by 25% in 1H03. If the trend continues, US imports from China would reach US$156 billion this year. US businesses would then add US$625 billion in value before the Chinese goods reach US consumers. This amount of value would be the equivalent to 5.8% of the US GDP. Moreover, this portion of the US GDP is probably more labor intensive than the US economy as a whole. I estimate it would imply that more than 8 million American jobs are tied up with the Chinese imports.

Could the US quickly switch to other sources? Who else has the scale and low-cost base to replace China? Since 1997, American consumers have already saved US$100 billion a year in the import bills just on the decline in the price of goods from East Asian relative to those from other regions. These savings have come as other countries in East Asia relocated their production to China. Would American consumers be willing to pay so much again to switch to another supply source? Now you can see why I believe congressmen are not smashing made-in-China products on Capitol Hill. If they were to do so, they would be smashing American jobs, American businesses, and American prosperity.

Let’s take the US statistics on China trade and see how much damage any disruption would hurt China. The value of the materials China imports to produce its exports to the US represents about 30% of the final value of the exports. The Hong Kong, Taiwan, American, or Japanese businesses that own the factories take away about another 15% of the gross sales as profits. This leaves 55% to represent the value added that benefits China, or about US$86 billion this year. China’s GDP should reach US$1.4 trillion this year. These exports to the US would be about 6.1% of China’s GDP. If the trade between the two countries were seriously disrupted, the extent of damage would be similar for China as it would be for the US. Furthermore, I believe US financial markets are much more vulnerable to any disruption in US-China trade. Profits for companies in the US retail and IT sectors depend on keeping supplies from China cheap. The market values of these companies would be severely affected if trade were disrupted. This is why I do not believe that the US Congress will bludgeon China into doing something harmful to the interests of the US. And, why I say it would hurt the US more than China.

The irony is that East Asia, including China, is losing market share in the US. The region’s share of US imports peaked at 40% in 1994, falling to 32.5% for 1H03. China’s exports to the US are rapidly rising, mainly because Japan, Taiwan, and other East Asia economies are shifting their production of goods destined for the US market to China. The relocation is generating cost savings that are being passed onto US consumers. The political rhetoric, however, could be ominous for the global economy in the long run. It could mean that the US commitment to free trade is not as solid as it was. It also reminds me of what the US did after the crash of 1929, when the bursting of the financial bubble led to high unemployment. The US Congress eventually legislated to restrict trade to protect jobs at home. As other nations also resorted to protectionism for the same purpose, it became a negative-sum game for the global economy that caused the Great Depression.
Source: Morgan Stanley Global Economic Forum

I'm not convinced that Andy is right about the last point. I don't think the Hawley-Smoot tarrif caused the Great Depression, which was anyway primarily a US phenomenon - I don't mean there wasn't depresion elsewhere, but that what Lionel Robbins called the Depression has very specific characteristics in the US. On the other hand, I think it is impossible to foresee whether there could be a US withdrawal from globalisation. I do, however, agree, that the consequences would be quite important, especially since it would probably lead to a less US centric global economy, and the US itself would probably have difficulty financing its debts. Something like shooting yourself in the foot, perhaps. But with the ideological climate in the US these days, virtually anything is possible. We may yet even get to see Bush and co joining forces with José Bose.
Wages and Deflation in China

In the mailbox, Stephen makes some comments on this . Some very interesting points, and he should know, since his job is researching this area.

Your 2 Sept 03 piece on China's 'reserve army' is interesting, but you may want to talk to factory owners in China before you start generalising about internal wage deflation. I take your points regarding xiagang, SOEs, etc, but minimum wages in China have shown pretty steady growth over the last decade (with Guangzhou - for instance - raising min wages five or so times in the last five years). Whether workers get paid those rates is another question, but given that we're now witnessing the migration south of garment factories (from Guangdong to Vietnam) might tell us something about Chinese wages. HK businessmen moving to Vietnam will tell you that high wages in China's south have had at least some influence on their decision to move, though of course there are many other reasons why someone shuts down a factory in Dongguan and moves to rural Vietnam. Shenzhen and other manufacturing centres in Guangdong have the highest minimum wages in the country (574 yuan per month for Shenzhen - off the top of my head...).

The interesting story, and one not often told, is about the competition between counties, townships and other administrative units over investment. Minimum wage competition is ongoing, with adjacent counties attempting to use lower wages to attract investment. People often quote stories about Malaysia losing contracts to China and so on, but wages competition is a much greater issue internally.

Second: everyone is talking about China sucking investment out of Southeast Asia, but far fewer are talking about China's outward FDI. It's growing rapidly and is making waves in Southeast Asia in particular. With large investments in Cambodia, Burma and Laos, the Chinese state is now in a position to influence ASEAN, much to the consternation of the Singaporeans and others. That China is probably (it's hard to know for sure) the largest investor in Cambodia is not widely understood, but the ramifications of this are pretty interesting.

Japan: Older Workers Moving to China?

Eddie writes from Spore:

I’ve attached an article that I thought was pretty interesting. A reverse labour flow - older workers to younger countries. If we had an even flow in either direction, it would really breakdown ethnic barriers. Imagine Shanghai having as many Japanese as Tokyo had Chinese. That would balance out the demographics in the 2 cities. There was a story a month back about a Singaporean private collage looking to employ ‘retired’ teachers and civil servants to teach in China. But right now, the balance of flow is of course one-sided. Growth attracts more growth. And the stagnant economies just see a hollowing out.

Japanese job-seekers heading to China

Older Japanese workers with skills and experience but who have lost their jobs at home are turning to work in China
By Kwan Weng Kin

TOKYO - Shanghai-based human resources executive Sun Liping, 40, has a dream. He wants to boost the competitiveness of Chinese manufacturing companies in his native Shanghai, and hopes to do so by matching them with veteran Japanese workers who have the skills to share. Mr Sun, president of human resources firm Shanghai Chuangjia Consulting, knows the situation in Japan well, having studied here in the early 1990s. 'Shanghai's economic development has been very rapid. Some companies in our manufacturing sector are now very good but many are still far behind the Japanese,' Mr Sun told The Straits Times in a telephone interview. 'On the other hand, many Japanese middle managers, product development experts and so on are losing their jobs due to corporate restructuring. So there are Chinese companies which can benefit from their expertise. 'My company can help bring the two sides together.'

Fortunately for Mr Sun, there has been a steady number of Japanese in their 40s and 50s seeking second careers in China. As the percentage of jobless in Japan continues to hover around 5 per cent, China presents bright prospects for older Japanese workers forsaken by their employers. By last April, Mr Sun had received the details of some 1,400 Japanese job seekers, 70 per cent of whom have experience in the manufacturing sector, his main target. PaHuma Asia, a Japanese job placement firm headquartered in Hong Kong, has also seen a leap in applications from Japanese for jobs on the Chinese mainland. According to PaHuma's Tokyo office, 42 per cent of Japanese registered with it want to work in China. PaHuma also attests to the growing number of job opportunities in China for Japanese workers, not only in China-based Japanese companies but also in Chinese firms.

Ms Tomoko Hata, manager of PaHuma's Tokyo office, said: 'In the year ended August 2003, 35 per cent of our available positions were for jobs in China.' Most were in sales or technical fields. A survey released in May last year by the Japan External Trade Organisation (Jetro) noted that while Japanese companies were trimming expatriate staff throughout East Asia, they were hiring more Japanese personnel on local terms, particularly in China and Asean.
And while job placement agencies saw less demand for Japanese workers in Singapore and Hong Kong, they were dispatching more veteran Japanese workers to China and Thailand, said Jetro. Statistics compiled by the Japanese Foreign Ministry show that the number of Japanese residents in China has been rising in recent years, totalling nearly 38,000 as of October last year. Although technology industry workers draw higher salaries in Japan, the lower cost of living in China means they can live comfortably on their Chinese pay packets and still have ample savings. But as Mr Sun pointed out, problems in hiring Japanese go beyond monthly salaries. 'There are often language problems, issues with food and housing, even pensions. But we hope to be able to solve them,' he said. The Sars crisis earlier this year was also a major setback. 'We were unable to arrange interviews in China,' said Mr Sun. With Sars on the wane, he is looking to go full speed ahead to bring to Shanghai companies the Japanese talent they need to compete.

A report last year by chinanews.com said there was a shortage of personnel in the Shanghai area among the 20-to-40 age group who were familiar with leading technology.To plug the gap, Chinese companies are said to be willing to pay monthly salaries ranging from 20,000 yuan (S$4,200) to 50,000 yuan for a Japanese expert.This is several times what they would pay Chinese workers.Many companies have been able to attract workers previously at Japanese blue-chip firms, particularly in the electronics sector, which has shed thousands of jobs over the past few years through early-retirement schemes.Although such workers draw far higher salaries in Japan, the lower cost of living in China means they can live comfortably on their Chinese pay packets and still have ample savings.

Funnily enough this is something I often discuss with my wife. Spain in ten years time will be one of the oldest countries on the planet. In a society where everyone is old, the premium will be on young people, older people will, almost inevitably be less respected. That, in part explains why so many companies want to recycle their over 50 workforce. In contrast, those societies where there are still a disproportionately large number of young people (just sufficient, not tooooo many) will need the experience of older people, older people will be more valued and respected. Apart from relieving the burden on the welfare system (ironically, in a slightly poorer, but younger society, hospitals may be fewer in number, but access may be easier) it may be a good practical proposition for those over 55 who find themselves prematurely 'released' from their obligations in the west to recycle themsleves, and start a new life in one of the younger 'developing' economies. Apart from anything else, with the internet to accompany you, it might feel just like home.
Why This is not a Good Time to Revalue Renminbi

Following up on the China financial reform topic, here's Andy Xie from last Friday:

I believe China must reform its financial system before it can open its capital account and change its currency policy. The reforms are not just about solving the stock of non-performing loans in the banking system, but more importantly, they are also about stopping the banking system from accumulating more bad loans.

The non-bank financial sector also presents a serious risk to China’s stability, in my view. In particular, our strategist believes the stock market is overvalued; I believe it is not a level playing field.

Further, the inefficient financial system reflects the contradiction between the need to narrow the gaps in regional incomes within China and the inability of the government to collect taxes. If China does not streamline its tax system to raise national tax revenue to more than 25% of GDP, the central government will likely have to continue to rely on banks to support investment programs in poor provinces to narrow the gaps in regional incomes.

There is a race between GDP and bad debt in China. If the latter grows faster, as it has been in the past, China may need to devalue the currency when its exports slow down because inflation is needed to reduce the burden from bad debt. Although productivity gains may support a renminbi appreciation at some point, the financial system is distinctly pointing at the other direction. If you are betting on the renminbi today, I say good luck.
Source: Morgan Stanley Global Economic Forum

And don't miss this part:

For each US$1 in value for a product that China exports to the US, a product sells for US$4–5 at the retail level in the US. Therefore, American brand owners and distributors benefit far more from China’s output than the Chinese themselves. Moreover, for each US$1 in value for a product that China exports to the US, businesses in Hong Kong or Taiwan take 20 cents.

and remember, a lot of Chinese exports to the US are of products which originate in Hong Kong or Taiwan, and which have simply been 'processed' (assembled etc) in China. A revaluation of the Chinese currency would have no impact on the underlying value of the core components. So it is not clear that anything other than a sharp correction would have more than a negligible impact on the US trade deficit with China, and a sharp revaluation would surely be deflationary and destabilising (which would also amount to the same thing) inside China.
Bank Lending Rockets in China

Yesterday I was defending the Chinese economy from its sillier critics. Today, to show that I am not blind, a 'balancing piece' which indicates some of what the crtics are worried about: the system does seem flooded with liquidity. Chinese banks are increasing lending fast, and at very low margins (oh, oh!), and foreign banks seem to be shying away. I have to collect two books on Chinese banking and financial reform (courtesy of Amazon) from the post office this morning (thanks to Walter Hutchens for steering me towards them), so maybe I'll be a bit clearer on all this later in the week.

In the face of aggressive lending by local institutions, international banks' share of foreign currency loans fell from 15 per cent in 2001 to 7.4 per cent last year; and their share of total assets of the Chinese banking system dropped from 2 to 1.1 per cent over the same period. The figures, produced by European bankers ahead of the European Union-China summit in Beijing in October, have been taken from the People's Bank of China (PBOC), the central bank.

The market share of overseas lenders is likely to have fallen further in 2003, as Chinese banks' loan books have expanded even faster this year, prompting the PBOC to impose higher deposit requirements on most local institutions late last month. Lending last year rose 15.4 per cent year-on-year, said the China Economic Quarterly. But it has accelerated more rapidly in 2003, rising 71 per cent year-on-year in July alone, the PBOC said. "Chinese banks have a lot of liquidity, and so we are seeing a lot of aggressive lending in large amounts," said one Shanghai-based foreign banker yesterday. "One thing we have to alert clients to, is the fact that this liquidity might at one time end." A number of projects involving multinationals, such as Shanghai's new $12bn deep-water port and an LNG terminal in Guangdong, have been financed almost exclusively by Chinese banks. "It is not uncommon to see a 12-year project financing for less than a 1 per cent margin - there is no justification for us getting into this business," the banker said.
Source: Financial Times

Knock, Knock , Guess Who's There

Knocking China seems to be all the rage these days, in some quarters at least. Conrad the Gweilo for eg:

China's Growth Illusion

Weijian Shan, of Newbridge Capital, penned an extraordinary and compelling pair of opinion pieces in Wednesday and Thursday's Asian Wall Street Journal. in which he details China's illusory growth, misallocation of capital and sets forth how China can yet reform and avoid an economic collapse.

The pieces are extraordinary because, despite the fact that Newbridge has substantial mainland investments, Shen's analysis is devoid of the usual cant and brown-nosing characteristic of the public views of foreign investors in China. Indeed, Shan's honesty and bluntness are so unusual that it's caused something of a stir within the investment community.

Now since Conrad is no economist, and since to boot he seems to spend most of his weekends looking at photos of attractive young Asian girls, perhaps he can be forgiven for having left most of his critical faculties in another place, but then there's this piece (thanks to Joerg) from Hugo Restall of the Asian Wall Street Journal to contend with:

"So China is using the hard-earned savings of its people, which could have been devoted to building globally competitive companies, and is instead throwing them down 100,000 state-owned ratholes so that Chinese workers can produce artificially cheap products for American consumers to enjoy. The government is even taking away the dollars earned by selling these products and loaning them back to the U.S. at low rates so that those American consumers can keep on buying. There's still time for China to get wise. But the point here is that Americans should be sanguine about China's development model. Thanks to Beijing's own policies, China is giving them cheap capital, cheap manufactured goods sold below their true cost and a market for sophisticated, high value-added goods. At the end of the day, China will be left with uncompetitive companies, depleted savings and a balance-sheet recession. It will have to sell off the distressed assets of its failed banking system, at which point Western companies can buy up even more of the economy at fire-sale prices..."

To this concoction let's add a little quote from Arnold Kling back in June (which Joerg sent me this morning):

"Why do foreign investors invest so heavily in dollar-denominated assets and bear the risk of a decline in the dollar? Personally, I think it is because they are stupid.........The beauty of having dollar-denominated debts in a world of currency fluctuations is that the United States is fairly insulated. If the foreign currency crashes, foreign borrowers take the hit. If the dollar crashes, foreign lenders take the hit. Foreigners are screwed either way."

and it seems we have something less than an objective view of things floating around. In fact I have the feeling that there is a US wins come what may paradigm in the air. (One which may, or may not, be as cynical as the George Bush Iraq one, but certainly is just as much of a self delusion). As I said in my triple deficit post earlier this morning, this isn't how I read things. If anything the US may be the economy with the biggest problem if they don't find a fix, even if some non-US citizens who have their money in New York get their fingers burnt in the process. To dub China's growth process an illusion seems to be streching the fact that there are problems, and that they need to fix them, to really incredible limits. This isn't even schadenfreude, but maybe it is schadenfreude displacement, since it involves projecting your own misfortunes onto others in order then to take pleasure in them. As if to show not everyone in the US is so perverse, and uncharitable about China, Walter Hutchens has what seems to be a 'fair and balanced' account of the state of things:

Is there any Value to the RMB Re-valuation Discourse?

With a high level US official in Beijing and the US election heating up, noise is being made on both sides of the Pacific about the RMB valuation issue. I find it is beside the point.

Let's assume China "caved in" on this one and revalued the yuan as some US interest groups want it to do. Even if China dramatically increased the RMB's exchange rate (or even allowed it to liberally float), would this really change the fundamental reason the US is shedding manufacturing jobs and has a substantial trade deficit with China? I doubt it. The difference in PRC and US wages would still be dramatic, even if the yuan were revalued. Even allowing for the cost of transportation and some other inputs, how can a US union worker (or even a non-union one in say my home state of Alabama) compete with a Chinese worker in terms of the cost of labor? I don't see it.

Plus, I imagine computer technology and other efficiency gains have trimmed more manufacturing jobs than overseas competition in the aggregate, much less China's contribution alone, much less the part of China's contribution that is attributable to the falsely valued RMB.

Cheap labor is simply China's competitive advantage. If the RMB were traded 1:1 to the U.S. dollar, the cost of labor in China would still be much lower than the cost of labor in the US. So is this an economic or only a political issue?

And though I realize there can be enormous pain for the individuals directly affected, how would freezing in place these vaunted US manufacturing jobs be good for the US standard of living in general in the long run? Should we all agree to pay more for everything so we can say it was made in the US, or should we let the creative destruction of capitalism work its magic? Trying to give every worker an iron rice bowl is what China tried, and they didn't like the results and have been moving away from that approach for 20-plus years.

We certainly need to press China on lots of issues--and I, too, hope the RMB becomes fully convertible (so that creative destruction could come to China's stock markets), but pressing them to revalue the RMB for the purpose of keeping US factories running seems to me like a mistake. I doubt it will really help those factories much, and I doubt helping those factories, if we could, would really help the U.S. much.

China Mobile's Agile Movements

While the a strong whiff of 'promo' about this Finance Asia article, the details you can find there are real enough. China Mobile is now the world's No2 carrier in terms of subscribers, and set to rocket upwards if the market potential is anything to go by. This situation could also be revealing about the pattern which may be to come as China's internal market expands.

The company's position as the second largest mobile phone operator in the world by number of subscribers was bolstered at the end of last year with the acquisition of seven mobile phone interests in China. The acquisitions were funded by a $6.6 billion share placement and a $690 million convertible bond, the largest equity issue from non-Japan Asia ever achieved. With the assistance of its financial advisers, China Mobile Hong Kong's senior management showed a stroke of genius by registering the deal in the US which meant that a lot of institutions were encouraged to participate. The convertible bond portion of the transaction was 25 times subscribed.

"China is now absolutely in the super league, one of only a handful of truly global wireless companies," commented the head of equity capital markets for Goldman Sacks, Mike Ryan, following the successful deal.

From the proceeds, China Mobile (HK) was able to acquire seven mobile communications interests from China Mobile Communications Corporation in Beijing, Shanghai, Tianjin, Liaoning, Shandong, Hebei and Guangxi. "The acquisitions have significantly expanded the subscriber base and geographical coverage of our business," says Mr Wang. "The group's network in the coastal provinces of China now covers almost half of the population in China." As a result, China Mobile (HK) services approximately 53% of all mobile subscribers in China, with subscriber numbers exceeding 45 million by the end of 2000...............

"To build our wireless data business, we have established a joint venture with Hewlett Packard and other parties." The joint venture will focus on the development of wireless data-enabling technologies and applications. This will include a standardized nationwide platform for wireless data.

China Mobile (HK) formed another strategic alliance in February when it signed a deal with Vodafone to share management expertise and human resources as well as operational expertise. It will also participate in joint research and development in key technologies, infrastructure, applications and solutions relating to the mobile phone market. Vodafone's chief executive, Chris Gent, now sits on the board of China Mobile (HK) as a non-executive director, in part to assist the company in seeking new joint ventures and equity-based strategic alliances.
Source: Finance Asia

China's Enormous 'Reserve Army'

Here's another dimension of the China situation, and one that's likely to mean that prices stay down whatever happens to the yuan. The question is to understand the whole dynamic of what is happening. Introducing an enormous new labour supply from the rural hinterland into the new economic zones, and then systematicall folding the state owned industries on the fly creates a very special dynamic. And one that is liable to see internal wage deflation for some time yet.

China's soaring economic growth will not stop hundreds of thousands of staff at state-owned firms from losing their jobs in the next five years, the country's state media has reported. According to the China Daily, the main English-language paper, more than 2,000 state-owned enterprises (SOEs) will go to the wall. That, the paper warns, will further worsen China's already serious unemployment problem. "Further bankruptcy will make things extremely tough for redundant workers, and will probably exacerbate China's urban unemployment problems," the paper quoted an official from the State-owned Assets Supervision and Administration Commission (SASAC) as saying. Almost 8,000 SOEs have already gone bust - although another 159,000 remain in business, the paper said. China's government is keen to see the back of many more, since their inefficiency often means the goods they make are worth less than the cost of making them. Following the country's entry into the World Trade Organisation - and the resulting increase in imports - the mismatch is likely to get worse. State benefits for the unemployed are limited in China, remaining little changed from the pre-market economy days when everyone had a job in a state enterprise. That means those forced out of work may end up swelling the numbers flocking from the provinces to China's big cities and often ending up sleeping rough.
Source: BBC News

Anecdotal evidence from Peking Duck only confirms this impression:

I am no economist, but it appears to me that this is the conundrum of China's economy:

''The policy of allowing these loss makers to go bankrupt will make China's employment situation much tougher,'' the official was quoted as saying. State-sector reforms have led to the shedding of tens of millions of workers every year, many of whom cannot find new jobs. The Ministry of Labour and Social Security said that China needed an additional 24 million jobs for its unemployed urban residents.

That's 24 million jobs for urban residents alone. I don't even want to think of how many in the countryside are out of work. On top of this, the government is always borrowing more and more to support the non-productive, cash-bleeding SOEs, so the banking system is under perpetual strain.

And that's where the "maintain social stability at all costs" mentality steps in. Once you have any sort of panic, any run on the banks, the entire system is threatened. I realize the situation is more complex than that, but I was always aware when I lived there of just how fragile things really were.

A common myth, I believe, is that multinationals in China are thriving, and that the Chinese are lining up to buy foreign goods. I'll take that back -- it's half myth. There is no doubt a sliver of the vast population is indeed buying Mercedes sedans and Louis Vuitton bags. And the middle class is certainly growing, though I believe most readers would be amazed at what would constitute the "middle class" wages of, say, an accountant or marketing manager in Beijing.

I would guess that most of the Louis Vuitton, Ermenegilda Zegna and Hermes boutique shops that seem to be everywhere in Shanghai and Beijing are breaking even (maybe), thanks to that high-spending sliver at the top, as well as the expats. But I can't imagine anyone getting rich from them.

Most companies seem to feel they must establish a presence in China now and take advantage of the great marketplace of the future. ............Time will tell if this is an ingenious strategy or a doomed goldrush. I honestly can't say. Some are definitely doing very well, especially certain auto manufacturers like Volkswagen and Buick, which made shrewd deals to assemble their cars on Chinese soil. Others are operating at a painful loss.

One thing's for certain: the new pheomenon of the Chinese millionaire and of that small sliver at the top that can afford Prada bags and trips to Paris is a mixed blessing when it comes to holding the society together. Their money is certainly trickling down, but it also exacerbates the already shocking discrepancy between the nouveau riche and the dirt-poor peasant/migrant worker. The government appears to be truly concerned (justifiably, IMHO), about a possible "Let them eat cake" gulf between the rich and poor.

Kieran over at Crooked Timber had a piece last weekend about Nick Cristof and the China/Russia connundrum ( the latter has had a serious stab at political reform and has ended up with a deteriorating economy, while the former has had slender political reform, and a booming economy. That being said, if you talk to Chinese and to Russians about their respective societies, it is by no means clear that the difference is as large as it might appear to be. People in China certainly feel a lot freer than they did 15 years ago, and the Russians have serious problems with their political process).

I don’t think culture can be the right answer. It’s always tempting to reach for it when we’re faced with a very complex, nationally-bounded problem. But you have to be careful how you think about it. In this case, Kristof clearly thinks of national cultures as being pretty stable. But if they’re stable, how can they explain the huge changes in each country over the past decade? You might think that the shock of the Soviet collapse allowed Russian cultural tendencies to express themselves fully, but that’s not very convincing. Were they not expressing themselves fully between 1917-91? There hasn’t even been a similar shock in the Chinese case, so why all the changes?

The question Kristof asks is one of the Very Big Ones in comparative political economy, so it’s not fair to blame him for not solving it in a short column. The depth of the problem isn’t always appreciated. For instance, you might say “Yeah, the Russians were just as lazy and vodka-ridden under Communism, they expected the state to provide for everything and they still do, hence the lack of economic growth.” This vastly underestimates what’s happened to Russia since 1991. A good paper by Ted Gerber and Mike Hout lays out the early evidence of the disaster and shows how little of the “market transition” ever happened. (JSTOR subscription required.) Things have gotten even worse since then. I don’t have the numbers to hand but I think Russia’s GDP fell by about 40% over the 1990s. (I want to believe that it couldn’t be that much, surely, but the number is stuck in my head. Clarifications welcome.) Life expectancy is down by about five or six years. People in the Soviet Union might have gotten used to state provision of services, or have a cultural tendency to sit around the table and drink, but I don’t see how that explains such a gigantic drop in economic output and basic life-chances in a country the size of Russia.

If the macro, long-term “Culture is to Blame” explanation is unconvincing, the micro, short-term “Economists are to Blame” explanation doesn’t work either, and for the same reasons. The neoliberal policies demanded by the IMF and thought up by U.S. economists haven’t done any noticeable good. They’re usually diagnosed (often now by their originators) as having failed because evil crooks got hold of all the assets in the economy. But again, there’s the sheer scale of the problem. Even if this is why the policies failed, it doesn’t seem sufficient to explain the catastrophic outcomes. Especially when you remember that — as Ronald Reagan kept telling us in the 1980s — evil crooks were in charge of all the assets when Russia was still part of the Soviet Union, too.

All of which leaves a non-specialist like me a bit confused and wanting to do more reading that I don’t have time to do.

I tersely posted the comment that you might try looking at the demography. Virtually no-one took up the suggestion. It's like we're all colour blind. There is virtually no way that the 'transition countries' can have sustained growth with their demographics. I would bet anything you like that 90% of the explanation for the China-Russia difference can be understood in these terms (I would also bet that 10 years from now a lot more people will be prepared to agree with me). It may seem simplistic, but it could be just that simple (wasn't it Einstein himself who recommended keeping theories simple - just as simple as possible, no more than that). The other thing I noticed about the comments was the underlying cynicism of many in Western Europe and the US about the Chinese reality. We keep going back to the 'they rig the figures argument'. Sure that's probably partly true as we've seen with SARS. But there are other 'proxy' measures which are being used by good economists like Andy Xie (who the Crooked Timber crowd don't seem to have heard of!) to get an independent perspective. Or there is the argument that US corporations are going to China to lose money, just because it's fashionable (my guess is that people who make these comments don't understand much about accounting procedures, or about why the US is having a jobless recovery). However, it is also true, as Peking Duck observes, that the poor may be getting poorer, but this also happended in the UK in the first half of the 19th century, and in the US around the turn of the 20th century, and look what happened next. I hate to say this (especially given the ideology that they profess), but a lot of this smells awfully like 'eurocentrism' to me.
China Readies its Excuses

John Snow is about to visit China, and the Chinese are preparing their excuses. Despite all the comparisons with Japan I think it is imporant to understand that the dynamic is going to be very different. Since 1945 the Japanese have never been prepared to confront the US head on. It was only two years ago that Beijing took down a US airplane and refused to back off. Ironically the more pressure the US tries to apply, the more resistance they may encounter. Which doesn't mean that the yuan will not go up. As the spokesmen say, the only firm decision is 'not now'. China will make concessions, but not on fundamentals in my opinion. Essentially I think Andy Xie is right, the most interesting thing for the Chinese to do right now (speaking only about economics) is to fix their financial system. Removing subsidies is only a token gesture, since a 5% increase in costs inside China only translates into a very marginal price change in the US. Really the problem is not that China is exporting too much, it is that the US is exporting too little. That problem can only be solved inside the good ol' US of A (perhaps with a little help from Europe and Japan, who are, after all, the main customers).

China is preparing to reduce incentives for exporters, increase purchases of Treasury bonds and loosen controls on foreign currency holdings to blunt mounting pressure from the United States, where its growing trade surplus has come under heavy political scrutiny, Chinese officials and analysts say. The steps are expected to be among concessions Chinese leaders offer Treasury Secretary John W. Snow on his visit to Beijing this week, although they fall well short of meeting Mr. Snow's demand that China begin allowing market forces to set the value of its currency, the yuan. With Democratic presidential candidates, influential American manufacturers and even Alan Greenspan, chairman of the Federal Reserve, pressing China to overhaul its currency system, officials here are eager to head off trade tensions. But they are also determined to maintain the current exchange rate, set at roughly 8.3 yuan to the dollar, for some time to come. "People do not want Mr. Snow to go away disappointed," said a financial expert affiliated with China's State Planning Commission who has been involved in preparations for the visit. "But the decision on the yuan has been made. There will be no change at this time."

The issue reflects the growing sensitivity of China's trade surplus in the United States and its robust economic growth, which some critics say is coming at the expense of American jobs. It is also an early test for the new generation of China's leaders, who will be called upon to handle inevitable diplomatic frictions as the country attracts tens of billions of dollars annually in foreign investment and posts year-on-year export growth of more than 20 percent, much faster than other major economies.

China passed Japan last year as the country with the largest trade surplus with the United States, at $103 billion. That has made it a prime target for producers of textiles, auto parts and other ailing industries, which say China is stealing their business by currency manipulation. The situation is reminiscent of economic tensions with Japan in the 1980's. China today and Japan then had rapidly growing trade surpluses and currencies that many analysts said were kept artificially cheap to promote exports. On his first stop today in Tokyo, Mr. Snow took veiled aim at both the weak yen and the weak yuan. Yet China's economy now is more open to foreign investment than Japan's was then, and multinational companies like Dell and Wal-Mart influence China's low-cost production as big employers and purchasers. China's leaders know this makes it less likely that they would face heavy trade sanctions, as any penalties would raise the price American consumers pay for goods as diverse as socks and laptop computers, analysts say.

Chinese officials are preparing short-term measures to channel more of the country's export earnings into the international economy without changes in the exchange rate.

One step is to cut or eliminate some export subsidies that give its industries a further competitive edge. Among the possibilities under discussion are steps to cancel or sharply reduce tax rebates paid to exporters in sensitive industries like textiles, shoes and furniture. Mr. Xie (that's MS's Andy Xie, Edward) estimates that a reduction in rebates could force companies in the industries involved to raise their prices by about 5 percent. That could eliminate some of the gain from recent swings in the value of the dollar, although given the enormous cost advantages of producing such goods in China, it would probably do little to stimulate manufacturing in the United States. China is also using its large pool of foreign currency reserves, which now total $356 billion, to buy more United States Treasury bonds. In the first six months of this year, it bought a record $41 billion of Treasuries, less than Japan but far more than any other foreign country.
Source: New York Times

Chongqing, China's Gateway to the West?

First of a series of pieces by Andy Xie that I missed while I was on holiday.

Chongqing markets itself as China's Chicago. It is situated at the upper reaches of the Yangtze River, about 1,500 kilometers from Shanghai at the river's mouth. Its population is 31 million, of which 11.3 million are urban. The city was part of Sichuan province and was elevated to provincial status to better handle the Three Gorges Dam project. It is quite hilly, surrounded by high mountains that trap the summer heat within, when temperatures hover around 40 degrees Celsius. Its population centers are separated into pockets by steep hills. Tourists usually come here to embark on the Three Gorges tour, but seldom spend much time in the city itself.

Chongqing probably came into existence as a trading port, linking the rich Chengdu plain with the rest of the country. Its culture has been shaped by the harsh working conditions at the port. The enduring image of the city is rows of coolies pulling boats from the shore into navigable waters. Cheap muscle power defined the city.

Chongqing is not rich, but people enjoy a comfortable life. We estimate that per capita income is about US$850 for 2003, or one-third the level of the coastal areas. However, prices are about 30-50% lower. Foodstuffs are plentiful, of good quality and cheap. Housing is still dominated by public housing compounds -- spartan concrete blocks with small units.

The local economy is totally dependent on investment. Fixed capital formation accounted for 47% of GDP last year and probably more this year. It was 35% in 1996. However, investment cannot support the economy forever, as the infrastructure set up would not be able to create value without competitive industries to take advantage of it. On that score, the jury is still out.

Huge investment in the Yangtze Delta eventually paid off in the form of that region’s export success. The region now accounts for one-third of China's exports. Chongqing's export industry, however, takes a week longer than the coastal region to turn around goods, and thus suffers a severe disadvantage in the export market.

However, geography does not rule out exporting goods. Although Chongqing cannot compete in bulky consumer products that require rapid turnaround, it could succeed in higher value-added products that are not time-sensitive. The city's exports reached US$1.1 billion last year, or 4% of GDP, but grew by 46% in the first half of this year. It is conceivable that its exports could triple in five years, which would go a long way to paying for the current investment boom. To achieve that, I believe Chongqing needs to overhaul its productive sector.
Source: Morgan Stanley Global Economic Forum

On Exporting Men and Technological Leapfrog

In the mailbox, Joerg has some reflections on my China post yesterday, and on the potential for third world technology leap-frogging.

Your latest post on China reminds me of a quote Schwartz uses in the book. In the Wilhelmine era, German chancellor Count Leo von Caprivi said: "We must export. Either we export goods or we export men. The home market is no longer adequate." China would then seem to be the first country that needs to do both. (Of course, the real point is the misguided ideology expressed in the quote. Communist China may well have moved along a path fairly close to the optimum since Zhou En Lai´s reign, but there certainly are no guarantees it will do so in the future.).............

You obviously rely on Schumpeter for part of your argument. I see several weaknesses in his theses. Long cycles are characterised by substitution of primary energy sources. While developments in the energy sector certainly contribute to the rise or downfall of individual entrepreneurs - Rockefeller is a name that comes to mind -, the process of energy substitution itself is accelerated (or held back) by political decisions. Without highways, there would be a reduced demand for automobiles and oil. A recent German study suggested that China would be the first country to boast a hydrogen economy. Such an outcome would not be due to the creativity of the Chinese - all the technological pieces of the puzzle are in place already. The problem is that the "early adopters" of such technologies are not individuals and small companies but those that finance, regulate, build and operate grids and networks that ensure distribution and supply.

Work on electric cars has been continuing for about one hundred years now. That is how old the discovery of the basic principle they are based on is! (BTW, fax technology was invented at the same time - many decades before it took off commercially).

I can make sense of Schumpeter´s term "overinvestment" - if I twist it a bit. Firstly, we would have to separate stock market investments from real investments by companies listed on the stock market - i.e., separate the undeniable maniacal excess from the uses the more sensible companies put it to. It is just not true that there is a lot of optical
fibre in the ground that will never be used, e.g. Secondly, the war in Iraq was a misguided investment in oil. A back-of-the-envelope calculation shows that levying a tax on gasoline to encourage energy savings and then investing the proceeds into subsidising/tax-exempting the energy infrastructure of the future would have been a much more efficient course for the U.S. to take.

The situation with technological leapfrog is really fascinating. There is a standard problem in conventional economics known as the 'incumbents problem'. Simply put this implies that those that have have an inbuilt interest in strategic defence rather than innovation - read Coca Cola, read Disney, read Microsoft. The incumbent, and in particular in the context of the new economy, increasing returns dynamic defends what it has. Now the interesting point is that this can be extended to states. States have infrastructure, and tend to be conservative in adapting to the new. With technological change in constant acceleration mode this becomes very important. We now have the exciting possibility that some of those perennial third worl technological outsiders could become the early adopters of some of the next generation technology. Joerg's example of alternative fuel sources for transport needs is just one, China and India do not have the same investment in gasoline station networks. wCDMA could be another case. It is clear that what appeared to be a decisive European UMTS lead three years ago could in fact turn out to be a milstone round our necks as both China and India may go for the much cheaper 2.5 generation upgrade. And then watch out, since any first in new technology in the third world would be an enormous confidence booster.

Most of China's state-owned telecom operators are likely to adopt the WCDMA 3G standard, Dow Jones reported. This would be a blow to the companies that are backing alternatives, including Qualcomm, which is developing cdma2000 technology, and state-owned Datang Telecom, which is the main developer of the TD-SCDMA standard. However, Dow Jones reported the final decisions are still some way off, as the Chinese government is yet to issue operators with business licenses for 3G mobile services, and hasn't given any indication when it will. "The ideal timing for the issuance of 3G licenses remains a topic of hot debate within government circles," Norson Telecom Consulting said in its report, but added it's likely each of the four major operators will get a license in the second half of 2004. The plans for two of those operators are fairly clear. China United , is focusing most of its energy on its CDMA2000 network and is likely to follow the established upgrade path to the 3G version, CDMA2000.

China Mobile is expected to adopt WCDMA, which is considered the easiest upgrade for its GSM standard network. The wild cards are China Netcom and China Telecom Group, which don't have conventional mobile phone networks and so don't face upgrade issues. Norson argued that both are likely to choose WCDMA. "China Telecom... has halted TD-SCDMA testing and shifted its focus to WCDMA. China Netcom, in line with strategic partner Singapore Telecom, has also shown a preference for WCDMA," the Norson report said.
Source: 3G News

Alcatel announced that R&D in 3G will constitute a significant portion of the $US 100 million R&D investment in China this year. In addition to R&D, investment in 3G infrastructure and application development in China will be increased by $US 45 million. This substantial commitment will further be used to strengthen its R&D, localization, and the 3G Reality Centre to support China's 3G development.

With the enhanced 3G capability, Alcatel Shanghai Bell, will be able to firmly support operators in China as they prepare for 3G commercial deployments. The company's 3G Reality Centre in Shanghai, which provides a fully-featured and live 3G environment for testing innovative applications and services with local partners, will also be further enhanced to meet the fast growing demand for new mobile applications in China.

The 3G Reality Centre in Shanghai has already conducted laboratory and field trials on 3G infrastructure and new mobile applications in China. The Centre is also the heart of Alcatel's 3G Reality Centre network in Asia Pacific and is connected online to an equivalent Centre in Paris

"We firmly believe that China, an emerging hotbed of mobile applications, will take on a leading role in the field of 3G worldwide," stated Philippe Germond, President and chief operating officer of Alcatel. "Alcatel is fully committed to partnering with Chinese operators to develop successful 3G services, bringing our industry-leading solutions, world-class R&D, global experience and building this into a full long-term applications capability within China."
Source: 3G News

Blogland in China

T-Salon is back from her Rocky Mountains holiday and she has forwarded me links to two new China BusinessBlogs. Firstly Fons Tuinstra is a Shanghai based journalist working for Chinabiz. Last Friday he reflected on the state of business journalism in China:

In one of the standard phrases I use to introduce Chinese media to newcomers in this city, I tell them that reporting on economy and finance has gone up, both in volume and in quality, over the past few years but that none of the Chinese media would have an authoritative position as a leading paper at this stage ¨C making it very hard to follow all the information available.

Mostly my visitors take my input for granted and move on to the next subject, but last week one of those smartarses started to ask me questions. ?°Who do you think is the leading English-language information source on China,?± she asked after my introduction. I was lost for a moment. Since Chinabiz is running an English language headline service, I do see the most important news about China in foreign media and I could not come up with an answer. Up to five years ago, I would have probably mentioned the South China Morning Post, but I stopped reading that paper when it started charging for their online access and I have not felt I have missed a lot since then. This month I cancelled my subscription for the Far Eastern Economic Review, the last subscription I actually paid for. I can read their articles at the site of the Wall Street Journal for free so why should I pay?

Chinese English-language media might be offering more and more reliable information than in the past but at times when you really need it ¨C take SARS ¨C they would rather toe the official line than tell the truth. I can deal with that, since I have learned to read between the lines, but it will stop them from becoming really mainstream or even leading media. In Amsterdam and New York they can read the People?¯s Daily online nowadays, but that does not mean they can make sense out of it.

Then there is Walter Hutchens a US academic who specialises in law and Chinese financial institutions. His material is technical (often linking to direct sources in Chinese) but he does promise to give an informed (and 'fair and balanced') view of what is happening as it happens:

PRC leaders constantly "zhi chu." The lead stories on nightly CCTV broadcasts routinely feature a top leader "pointing out" (?¸³?, zhi chu) this and that. Stories in the print media also regularly have some official pointing out, emphasizing or "revealing" a litany of platitudes. In fact, the sarcastic piece that got the Beijing Xin Bao newspaper permanently shut down listed just this as one of the "7 disgusting things" about the PRC. It lamented the way top leaders "zhi chu" obvious things such as, "when you are hungry, you should eat," or "when it is cold you ought to dress warmly."

Lately Shang Fulin, the head of the CSRC, has been busy "zhi chu-ing." Often he points out that reform (gai ge) and cleaning up (gui fan) of the PRC securities markets must be kept in pace with development (fa zhan). I think these comments, though vapid on one level, do have some hermeneutic purpose. They are readable tea leaves. I take them to express that a different political or policy "line" exists under Shang than under Zhou Xiaochuan, the former CSRC chairman. Zhou sometimes expressed the idea that it is not the job of regulators to assure that investors profit. Rather regulators are simply to enforce the laws. Shang, I think, is saying that law enforcement has to be moderated so as not to disrupt the development of the markets or unduly affect existing share prices.

Obviously these blogs are only of interest to the dedicated China watchers among us, but I am posting in the hope that I may not be the only one around with sufficient curiousity. BTW, on the 'Fair and Balanced' front I am greatful to Dave for letting me in on the joke, which has lead me to pull some fairly silly comments I made in an earlier post, my only excuse for missing out on the action is that I must have been asleep on holiday. Only one quibble, wouldn't it have been better for everyone to put something like 'slanted and sensationalist' on their blogs. The 1930's surrealists had in this sense a much more effective idea of protest, and I have always been most impressed with their idea of using the vous form for their closest friends and children, while relegating the rest of the world to being the mere tu (the French for this being vousvoyer and tutoyer) so you put the 'other' in the ridiculous position of asking whether they can 'vousvoyer': lovely. By the same token if you call your blog superficial, ill-informed and inaccurate, then you sure as hell take a lot of ammo away from your critics in advance. Bottom line: I don't see any point at all in attacking directly certain kinds of extremely stupid media, I think it's better just to ignore them completely.
Now It's Nortel on the India-China Trail

Nortel just joined the growing list of companies seeing expansion in China and India as the solution to the growth slowdown in the OECD world.

Nortel Networks Corp, one of the world's largest telecoms gear makers, expects rapid growth from the booming Indian and Chinese mobile phone markets to partly offset tepid global demand, top officials said."The telecom equipment markets globally are still quiet, but good growth is coming out of the Asia region: especially India, China," said Vivian Hudson, president for GSM sales and wireless Internet solutions at Nortel, late on Tuesday.............. Hudson, a 15-year Nortel veteran on her first visit to India, said telecom gear makers are bullish on India, if only because just five out of 100 people have phones.

"India has probably one of the highest capacity requirements in the world just by sheer size of the population, Paris-based Hudson told Reuters in an interview. "There is no question that you will be right up there with the Chinese and other major Western markets." India has more than 16.3 million mobile phone users, and analysts expect the number to surge to at least 100 million by 2008, or about 10 percent of its current population. China is already a much more developed market: It has some 240 million mobile phone users, or about a fifth of its population. One reason for the heady growth projections: India's hotly competitive cellular sector has the world's lowest tariffs at about 1 rupee (2 U.S. cents) a minute.

"The rate structure for wireless in India is very attractive. If its more affordable, more people will get in," Hudson said. The nine-year-old sector will need more than $60 billion this decade to push phone penetration to 15, the current global average, analysts say. Nortel doesn't break down its India business but it reported Asia Pacific wireless revenues jumped 49 percent in the second quarter, the highest gain of any region. Total Asia-Pacific, Latin America and Caribbean sales rose four percent to $467 million, or one fifth of the total -- the only geographical segment to post growth. Limited mobility services that work on CDMA (Code Division Multiple Access) technology and have 3.5 million users are expected to experience even faster growth. The number is rising rapidly as firms now tap smaller cities and rural areas.
"Without a doubt India is the largest unserved market for telecom services in the world," said Ashoka Valia, managing director for Nortel's Indian operations. "India is a clear strategic market for us because of the potential and the opportunity here." India's demand for wireless telecoms gear peaked in 2002 as private firms such as Bharti Tele-Ventures Ltd (BRTI.BO), 16 percent owned by Singapore Telecommunications, state-run Bharat Sanchar Nigam Ltd and the powerful Reliance (RELI.BO) group set up nation-wide telecoms backbones for their services. "Last year was a record year in terms of growth and sales," Valia said. "A key opportunity for Nortel is in the wireless equipment business. We expect it will be one of our growth drivers in India."
Source: Yahoo News

The Precarious State of China's Financial System

Just in case any of you were under the illusion that I thought everything in China was going to be just plain sailing, this article from finance Asia on a conference in Beijing last week about the problems with China's Securities Regulatry Commission should set things straight. The Chinese economy will never be able to enjoy stable sustained growth until it sorts this mess out. Of course the other side of the problem is: if and when it does how the hell will the US be able to continue to find the purchasers of dollar denominated assets which fund the deficit?

An extraordinary sense of gloom surrounding the securities market has emerged from a top level finance conference held last week in Beijing. The gathering of leading financial executives was notable also for being the venue for CSRC chairman Shang Fulin's first big speech. But other than promising that China's 130 securities companies were on track to be given permission to issue bonds publicly and by private placement, Shang didn't announce any new market boosting measures. That promise, long in the works, failed to spark the markets which saw thin trading of RMB4-5 billion in volume on both the two exchanges on the days of the summit, while the Shanghai Composite index dropped below the psychologically important 1500 mark. Despite economic growth averaging 8% over the last two years, the market's last high was 2200 in June 2001. In fact, the markets are in a very serious condition, say observers, who point out that they are not fulfilling any of their three functions of raising capital, pricing capital and acting as a barometer of the general state of the economy.

Figures show that China's stock market could, rather alarmingly, be slowly dwindling away. For example, the ratio of the funds directly raised in the capital markets to all funds raised has actually fallen to 5% compared to 8% in 2001, according to figures from the central bank. And last year, according to figures from the CSRC, 122 companies raised RMB78.8 billion ($9.39 billion), only 67% of what was raised in the previous year. In the first half of this year, only 58 companies have issued shares, raising just RMB32 billion, or around 80% of the amount raised last year for the same period.

The decline in direct financing is not of course, just a problem for the CSRC, it's also a problem for the whole economy since so much of the systemic risks fall on the banks - rather frail vessels, as has been widely reported, for such trust. The main victims of this situation are the securities companies, and sector reports estimate that the whole sector in the first half of this year saw a reduction of 5% on its stock trading, 44% and 47% respectively on fund and bond trading and that underwriting revenue was only 40% of the same time last year. In 2002, the sector made a loss as a whole of RMB 2.6 billion from 51 companies in the red. Of course, the CSRC is in an impossible position. On the one hand, its young technocrats want to introduce a first class capital markets system. But to do that it has to rout out many of the existing ills - potentially crippling market confidence in the process. Indeed, corporate governance was one of the focuses of the summit, with an emphasis on finding ways of preventing the brokerage houses misappropriating customer funds.
Source: Finance Asia

Power Consumption in China

While we in Europe continue to sweat and sweat under the sustained pressure of the summer 'canicule', the Chinese appetite for fuel consumption continues to grow and grow. Logically there is a problem somewhere. The French nuclear industry seems to have been built under the impression that the important temperature calculations were those pertaining to the interior of the reactor. It never seems to have been contemplated that the melt-down could be precipitated externally. Result: the nuclear industry is now functioning at reduced capacity, with the reactors being hosed-down externally, and the water being fed-back into the rivers at temperatures of around 30 degrees centigrade. Assuming that it's a good first guess that some of this climatic change is related to CO2 emmisions, what exactly is the plan?

China's orders for new power equipment so far this year have outstripped its purchases for the whole of 2002 by 50 per cent, as a restructured local industry attempts to keep pace with surging demand for electricity from industry and households. The purchases of power equipment in the seven months to July will add 30 gigawatts of new capacity to the national grid, equal to nearly 10 per cent of existing capacity, according to a survey of orders conducted for foreign energy executives.

The rapid growth is helping multinational infrastructure companies such as Siemens and General Electric compensate for weak demand in Europe and the US. GE Power Systems was aiming for $1bn of orders in China this year, but has already signed a $900m deal for 13 new gas turbines providing around 5 gigawatts. This year's orders compare to total purchases of 20GW worth of equipment last year, itself much higher than the two previous years, after a government moratorium on capital spending in the industry. At this rate, China could this year order new capacity almost equivalent to the UK's entire peak electricity demand of 55 GW. "The bottom line is they need to generate more power, so they are ordering equipment," said Joseph Jacobelli, an analyst with Merrill Lynch in Hong Kong. The survey for the foreign executives covers purchases only for thermal plants, which are mainly coal-fired, and does not include new capacity for hydro-electric or nuclear power.

The greatest growth in demand has come from increased industrial production, barely interrupted during the Sars crisis, and investments in power-hungry aluminium smelters. The rapid expansion coincides with an extended heatwave in parts of China, especially around Shanghai, which has forced the government to ration power to some factories and even close them on some days. Tan Yin, a researcher at Guangfa Securities in Guangzhou, says local Chinese manufacturers will get orders totaling around Rmb30bn-Rmb40bn in 2003. But their problems in keeping pace with orders may leave opportunities for foreign companies to sell into the Chinese equipment market, executives said on Monday.
Source: Financial Times

China's recovery from Sars boosts oil demand

China's faster-than-expected recovery from the impact of the Sars outbreak has boosted this year's forecast for global oil demand, the International Energy Agency reported on Monday. The West's energy watchdog revised global oil demand growth in 2003 by 100,000 b/d to 1.11m b/d, for a total of 78.41m b/d this year. It also said global demand in 2004 is now expected to be higher at 79.48m b/d after revisions to its historical data raised the baseline of non-OECD demand upwards. The global supply of oil surged by 916,000 b/d in July to 78.64m b/d, helped by higher volumes from the North Sea and gains in Iraqi production levels. The bulk of the increase was from non-Opec production, which rose by 688,000 b/d. Crude oil prices rallied at the end of July, after spending much of the month near post-Iraqi war highs of close to $32 on WTI and at the top of the Opec's target $22-28 price range, the IEA said in its monthly oil market report.
Source: Financial Times