Fearmongering against China?

Ted C. Fishman, plugging his new book, China, Inc.: How the Rise of the Next Superpower Challenges America and the World, slams the Chinese for Manufaketure:

...China's appropriation and dissemination of the world's most valuable products and technologies, if they continue unabated, will ultimately mean a lot more than dollars lost. China's pirating and counterfeiting could radically change the way entertainment, fashion, medicine and services are created and sold. The companies, big and small, that Americans work for could be weakened. Chinese practices might reduce the prices of what we buy, by undermining the powerful companies that now control essential but expensive goods like drugs and computer software -- or these practices might, should China's unwillingness to accede to American copyright demands ignite trade wars, drive prices up. A U.S. consular official in China who requested anonymity -- few American officials are willing to speak openly about sensitive issues relating to China -- told me: "Nothing has a higher priority in our trade policy than the fight to protect American intellectual property. It is every bit as important an effort for us as the war against weapons of mass destruction."

A couple of days before that, in The struggle of the champions the Economist stated,

The [Chinese] economy is still in transition between dirigisme and free markets. Its political system can harness enormous resources, but ultimately undermines its own objectives in a paranoid desire to retain control.

That China intends to create world-class companies is indisputable. Appalled by the speed of western development and, rightly, attributing much of that to the success of western corporations, the central government decided some years ago that 30-50 of its best state firms should be built into "national champions" or "globally competitive" multinationals by 2010. At home, these companies would enjoy tax breaks, cheap land and virtually free funding via the state-owned banks. Abroad, the government would help them to secure contracts or exploration rights.

...Arthur Kroeber, managing editor of the China Economic Quarterly, argues that China's "unique combination of first world infrastructure and third world labour costs" and its focus on capacity building rather than technological innovation mean that corporate successes are more likely to be component manufacturers or processors of intermediate goods than global consumer brands such as South Korea's Samsung.

...China's consumer-brand and technology companies are struggling....Far from being world-class, Lenovo is less efficient than its domestic peers, says Joe Zhang, an analyst at UBS in Hong Kong. Some put its early success down to good government connections—it is majority-owned by the Chinese Academy of Sciences.

Another much-heralded company is Qingdao-based Haier....Haier lacks the cost control, production discipline, market dominance and sales support it needs to compete with foreign rivals outside China. Even at home it has had to resort to price wars to regain market share lost to better foreign products.

...Over the past decade, then, China has created some quite large companies. More than a dozen are in the Fortune 500 list, though almost all of those are domestic monopolies or near-monopolies, such as telecom operators or big commodity producers. A handful of others are starting to compete internationally, though mostly in niche markets and on price rather than with technology or brands.

But the global footprint of Chinese companies is still rather faint. Their outward foreign direct investment was just $2.9 billion in 2003, compared with the more than $50 billion that flowed into the mainland. China's stock of outward FDI amounts to $33 billion, less than half a percent of accumulated world FDI. These facts have led some long-term observers of the Chinese economy to the conclusion that China's industrial policy since the early 1980s essentially has failed. That might turn out to be premature. But one contrast is revealing: 20 years after the start of its rapid economic development a decade earlier, South Korea had built successful heavy industry groups and was beginning to lay the foundations for the technology and consumer brands people know today.

If anything, the gap between Chinese and foreign firms is widening, as the latter merge, reinvest the profits yielded by their scale economies and continually hone their management systems....

...the Chinese government, deeply afraid of a politically independent private sector, implemented reforms that have given state firms privileged access to capital, technology and markets. But in order for the economy to grow faster, the central government has allowed foreign companies into China at a much earlier stage of its development and these now control the bulk of the country's industrial exports, have increasingly strong positions in its domestic markets and retain ownership of almost all technology. The result is a corporate landscape of a few big private companies such as Huawei, a mass of lumbering state-owned firms and increasingly powerful foreign multinationals.

China's unreformed political system has a second unintended consequence. Like the bosses of South Korea's chaebol before them, Chinese managers respond to regulatory inconsistency and opacity by pursuing short-term returns and excessive diversification rather than by investing in long-term technological development. Most are unwilling to develop "horizontal" networks with customers, suppliers and trade bodies—which in other countries establish technology standards and foster confidence in long-term research. In China, a company's best defence against corruption and the direct political linkages that benefit rivals is often to avoid business collaboration entirely and instead build vertical links up the Communist Party hierarchy and curry favour with local bureaucrats.

The power of officials to change policy at a moment's notice (suddenly appointing a successful boss as governor of a province, for example) or implement it in different ways for different firms, combined with the impossibility of achieving economies of scale through mergers because targets enjoy political patronage, together explain why Chinese managers tend to leap from one opportunity to the next, trying to grab a profit before the rules and the competition catch up.

...In recent years China has averaged a $12 billion annual trade deficit in electronic goods, components and machinery, according to the Ministry of Commerce. Most of its "high-tech" manufacturing is actually low-value-added assembly. The really smart bits, such as integrated circuits, are imported. The government continues to direct research spending, focusing on risky "big bang" projects (like sending a man into space). Indeed, China's low wages actually provide a disincentive to such investment, since Chinese firms can often boost short-run profits by replacing capital with additional labour.

Not surprisingly, therefore, foreign companies control virtually all the intellectual property in China and account for 85% of its technology exports.

...Chinese companies struggle with challenges such as negotiating a cross-border partnership or exiting a loss-making activity, argues Gordon Orr at McKinsey in Shanghai. While multinationals import their most sophisticated business systems to China, improving productivity by 15% a year, Chinese companies still resort to "brute force"—throwing more labour and capital at problems, rather than thinking about new processes. Unless they improve, they do not stand a chance against world-class competitors, either outside their borders and soon not even on their home turf, warns Mr Orr.

China has so far failed to build world-class companies. Even the natural monopolies and resources companies are mostly just big rather than particularly efficient. In manufacturing, technology and consumer areas, a few companies are groping towards international competitiveness, but none are there yet. Nor will China necessarily produce a Sony or a Samsung. "People assume it is just a matter of time before China develops world-class brands," says Mr Gilboy. "But Chinese firms may not develop like Japanese or Korean ones did. China may be building a distinct model of capitalism with distinct firms." While American firms broadly excel at breakthrough innovations, and Japanese ones at process and incremental innovations, "China capitalism may simply be best at making things a lot cheaper." If so, China might do well to focus on building no-name component suppliers as Taiwan has, rather than home-grown brands as in Japan and South Korea.

For unless China institutes far-reaching political and structural reforms that give Chinese managers the confidence to invest in long-term technological development, it cannot readily build a globally competitive corporate sector.

Fishman may be a former floor trader and member of the Chicago Mercantile Exchange, but I'm not sure how much he understands about economics. In an editorial for the NYT he wrote several years ago, he said,

These days it seems that providing a simple drink of water is not so much an exercise in quenching the thirsty as in soaking them.

...In India, the Sarai Act mandates that an innkeeper give a free glass of drinking water to any passerby. Indeed, in most places around the world, giving strangers water is the bare minimum of humane behavior. Why is that not so here?

Actually, water shortages are becoming a world-wide problem, partly because people don't pay for it. As the Economist argued earlier in Priceless, a survey on water, one difficulty with water is

...man's extravagantly wasteful misuse of it. This stems largely from a wilful refusal to treat water as an economic good, subject to the laws of supply and demand. Water, the stuff of life, ought to be the most precious of all gifts. Yet throughout history, and especially over the past century, it has been ill-governed and, above all, colossally underpriced. Indeed it is often given away completely free. Not only does this ignore the huge costs of collecting, cleaning, storing and distributing it, to say nothing of treating waste-water and sewage. It also leads to overuse of water for the wrong things, especially for highly water-intensive crops. The best way to deal with water is to price it more sensibly—to reflect, so far as possible, the costs of providing it (including environmental costs), as well as its marginal utility.