China hotbed and Hartcourt is there - China important:
"It is the fastest-changing place on earth--and
maybe in history."
China on the Move
China is in the midst of a new cultural revolution, driven by economic growth and integration into the global market. What will this mean for its people? And the world?
FORTUNE
Monday, May 14, 2001
By Jim Rohwer
With unending squabbles over human rights and spy planes, it's easy to overlook what makes China important: It is the fastest-changing place on earth--and maybe in history.
It took Britain most of the 19th century to multiply per capita income 2 1/2 times. U.S. income increased 3 1/2 times in the 60 years from 1870 to 1930, Japan's six times from 1950 to 1975. But China is the fastest of all. Since emerging from economic isolation in 1979, Chinese incomes have risen sevenfold. If China's takeoff continues--and there's no reason to believe it won't, although there will be bumps along the way--the global effects of that transformation will be dramatic.
You do not have to open the history books or plow through tomes of economic statistics to understand this. Anybody who goes to China can sense it. Twenty years ago China was a drab place. People ate mostly noodles and rice, which were rationed. They wore baggy blue Mao suits and lived in cities where the lights were out by 8 p.m. Within ten years the amount of fish, meat, and other tasty things the Chinese had consumed increased three or four times. Today people in China's coastal cities are often dressed as elegantly as their counterparts in the West. Nightclubs are ubiquitous. Almost every home has a color TV.
Shenzhen, across the border from Hong Kong, is an extreme example. In 1980 it was farmland with a few hundred thousand people. Now its five million residents have China's highest average income and boast its highest density of Ph.D.s. Five years ago a sleepy area of Shanghai called Pudong was muddy meadow. It is now a gleaming financial and industrial center, growing high-rises and chip factories rather than rice. And the rate of change is accelerating. Says Jim McGregor, a Beijing-based American venture capitalist who used to run Dow Jones' China operations: "The next ten years will see exponentially more economic progress than the past ten years. Once you have a bit more freedom, the energy, greed, and ambition of the people will do a huge amount."
There are good reasons to think this progress will happen. For one thing, China has to come to terms with the rest of the world because it is so dependent on it. Exports last year were more than 20% of GDP and imports about 12%. The dollar value of exports has grown almost 150-fold over the past 30 years. Foreign direct investment in China is valued at about $350 billion, rising by some $45 billion a year--and foreign-owned firms account for about half of China's exports. China's entry into the World Trade Organization, when it happens, is certain to speed up the pace of reform as well as that of economic engagement.
Second, China is moving upmarket. Good figures are hard to come by, but Justin Lin, who runs the China Center for Economic Research in Beijing, thinks that productivity growth has been running at about 5% a year for the past 20 years--more than twice America's rate over that period and about five times faster than Britain managed during the Industrial Revolution. Margie Yang, whose high-end shirtmaking Esquel Group in Hong Kong has factories around the world, says that using exactly the same management and technical systems, her Chinese factories are almost twice as productive as any of the others.
China's pool of engineering talent is also stupendous. According to David Hale, global strategist for Zurich Financial Services, there are more than 9,000 Chinese Ph.D.s working in Silicon Valley, compared with 35,000 American Ph.D.s. Eventually, as many of their Taiwanese and Korean counterparts have started to do, they will drift home. In China itself, says Hanson Cheah, a Hong Kong-based venture capitalist, some companies are already creating world-class technology.
Finally, there is China's momentum. Lin points out that Japan's economy grew rapidly for 40 years, from 1950 to 1990. Given China's age structure, its ability to accumulate capital, and its potential for catching up technologically, he figures China could do the same for 50 years. We're just over 20 years into that time span. Suppose China grows for another 30 years at 8% to 10% a year. At that rate, by 2030 the Chinese economy would be roughly the size of America's or Europe's. Each Chinese would still have only about a fifth as much income as each American, but China's citizens would be incomparably better off than they are today, with travel, education, culture, and improved housing within reach of hundreds of millions more people.
As this process unfolds, China will face dislocations, political risks, and business opportunities all at the same time. Consider what is happening to its state-owned enterprises (SOEs). For decades they have been a drag, employing up to 120 million people in jobs and factories that were notably unproductive. And for decades, the government avoided doing anything about them. Now these factories are slowly but surely being dismantled. Since the late 1990s about five million workers a year have been laid off from SOEs, a pace that government economists expect to continue for the next three to five years. That is a lot of people to dismiss, especially with China's urban work force expected to swell by 40 million people in the next four years. At least partial privatization of all but a handful of SOEs is now the declared policy goal, with small and midsized ones already being sold off or shut down. By 2005 some 75% of China's industrial economy (and an even greater percentage of its rural economy) will be in private hands, compared with less than 10% in 1980. Prices as well as jobs are being left to the market. A calculation by David Mahon, who runs a Beijing-based private-equity fund for investing in China, shows that in 1985 only 2% of wholesale prices were fixed by the market; the rest were decreed by the state. Today it is the opposite: The market controls 98% of prices, the state only 2%.
The SOEs cannot be wound down without a radical shakeup of banks and the welfare system. This is beginning to happen. The big four banks account for 80% of all lending, and according to Hale, their nonperforming loans to SOEs have risen to as much as 40% of GDP. The result is that there is not enough capital to go around for businesses that could use it productively. So China has created four asset-management companies (one for each of its four big banks) to start taking dud loans off their books. That process has already shifted $100 billion, though it probably accounts for less than a third of the nonperforming loans. The banks are quickly moving their new loan portfolios away from the shrinking state sector and toward personal borrowers who are looking for new products like mortgages. Interest rates are gradually being decontrolled. And as banks are being modernized, so are capital markets. With a market cap of $550 billion, China's stock exchange is already the third largest in Asia (after Japan's and Hong Kong's). There are plans to expand the listings of private firms and make the markets more liquid by merging the boards for domestic and foreign investors and making it easier for foreigners to invest. The government bond market is also about to bloom as various reform efforts take hold.
Another push for financial reform is coming from what amounts to the privatization of welfare. Education, housing, health care, unemployment benefits, and pensions are all being reformed. Before, these things were delivered through the workplace. As the SOEs decline, that is all changing. A four-year-old housing-reform program that allows Chinese to buy their own homes, for example, has created a hot market for mortgages. A house-proud middle class is mushrooming, creating demand in industries like interior design, small-scale construction, and furniture.
The most important part of welfare reform, though, will be pensions. Like Japan and America, China has been running a pay-as-you-go system under which current taxes finance current benefits. This can't continue. The unfunded pension liability for the next five years will probably equal a quarter of this year's GDP. The BCA China Analyst, a Montreal-based newsletter, predicts that unless something is done the pension liability could reach almost 400% of GDP by 2030. A lot of things will be done, of course, including improving tax collection and increasing government-bond issues. The most significant result, however, will be a strong shove to the privatization of pensions and a deepening of capital markets.
To the extent that these reforms are carried out, social and political change must follow in their wake. Such a program is really an agenda to make China a modern middle-class society. The housing reforms, for example, almost duplicate the politics that created a robust home-owning middle class in the U.S. in the mid-20th century.
One sign of the speed with which the reform process is happening came in the census China carried out at the end of 2000. In the previous ten years, the share of the population living in towns and cities rose by two-fifths--to 36% of the population. The speed of this migration from country to town is sure to increase as WTO-mandated farming reforms begin to bite: Those who are now scraping a living from inefficient small landholdings will need to find something else to do as the market opens up to foreign farm products and practices.
The implications of such a massive population shift are breathtaking. In the next decade Sichuan, a bucolic and fertile province in the southwest, is reportedly planning to develop nine new cities, each with a population of at least a million. The social and political effects may be even deeper, as these new and better-informed city dwellers begin to demand more say over how they govern their lives, including what they read, see, and talk about.
Even China's more conservative leaders--those who are wary of or even hostile to joining the WTO--grasp this trend. As McGregor says of China's leaders: "They're changing because they have to change; people have received too much freedom to be controlled as before." No one would describe China as a liberal place. But the steady increase in freedom is real: Even taking into account the crackdown on Falun Gong members, there is much less control over people's personal behavior and the press than there was just five years ago. In addition, a new generation is preparing to sink its teeth into power. J.P. Huang, an energetic Beijing-based private-equity investor with a Ph.D. in finance from the Wharton School, points out that people like him, who got their higher education just after the Maoist era was laid to rest in late 1970s, are familiar and comfortable with the ways of the West. They have a completely different view of the world than their elders, who were shaped by war, revolutionary struggle, and an inward-looking paranoia and ignorance about the world outside China. One consequence of the growing influence of this more worldly generation, he suggests, is that China now needs less intermediation from Hong Kongers or western China "experts" to do business with multinationals. Another is that this core of fortysomethings, who, Huang says, can "talk and think like Americans," is about to revolutionize Chinese society. In politics, individual freedom will loom larger and larger; in business, more modern standards of accountability and transparency will take hold. The timing may be in dispute--Huang thinks the difference will be evident in five years; Singapore's Senior Minister Lee Kuan Yew says 15 (see Lee on China)--but the trend is not.
All this will create new market opportunities. The financial services industry, for example, has enormous potential. So does telecommunications. There are those proliferating mobile phones, of course, and a 10,000-mile fiber-optic network that will link most of the country's big cities is about half completed. The most explosive growth, however, may come in media and entertainment. Within three or four years Chinese will be second only to English as the language of the Internet. Despite current tight controls by China's suspicious security and propaganda services, older media, too, are likely to blossom.
Li Yifei, the 38-year-old head of MTV's China operations, says that in the past year or so "there's been a swell of change underneath the surface" of the media business, driven by the liberalization of telecommunications and the competition of telecom operators with the cable TV industry. Cable, says Li, passes about 80 million Chinese households--containing some 250 million people--and about a third of the network has already been upgraded to interactive-video quality. Foreigners remain on a tight leash, but Li foresees a breakthrough in the next couple of years that will allow them to begin buying into distribution channels and offering more content. This is why companies like Disney and Rupert Murdoch's Star TV are eyeing China with such keen interest.
Sure, global companies are moving into China, but China is also making its presence felt abroad. Even after the Asian currency devaluations of 1997-98 lowered costs for almost all of its neighbors (China did not devalue), Chinese labor costs in dollar terms were still only about 7% of those in South Korea and Taiwan. The result: China has been taking market share from the rest of Asia, displacing Southeast Asia from the top of the (non-Japanese) Asian pile in exports to the U.S. The world's toys, clothes, personal computers--they're mostly made in China now. China has become the workshop of the world.
Japan already imports more from China than it does from all of Europe. The shift to China in the sourcing of much of Japan's low-end manufacturing and high-end farming will continue. One of Japan's most successful retailers in recent years, a discount firm called Uniqlo, runs 80 factories in China that churn out millions of fleece jackets and other clothes for its stores in Japan. Expect this trend, which accounted for a $25 billion trade deficit in Japan last year, to spark increasingly cantankerous trade relations. Japan already imports 60% of its towels from China, for example--and the towel makers' association is squealing for protection. In early April the Japanese government restricted the importation of leeks, rushes (used for tatami mats), and shiitake mushrooms from China.
Shrieks of towel makers and leek farmers aside, such trade flows confirm the extent to which China has become integrated into the world economy. In particular, the financial and business network tying China and Taiwan together has become increasingly tight-knit. Early this year Jimmy Lai, 52, a China-born businessman who made his name as a maverick clothing and publishing entrepreneur in Hong Kong, picked up stakes and moved himself and his family permanently to Taipei. Hong Kong, Lai reasoned, had been instrumental in the first 20 years of China's opening and modernization, but no more. It is now "irrelevant, in the major sense of being unable to influence China further," he argues. "The future of China starts from here [Taiwan]." Lai plans to duplicate his Hong Kong publishing empire in Taiwan, using it as a base for an eventual push into mainland media. That he considers this even a possible dream assumes fundamental change in China: Lai was China's least favorite Hong Kong businessman and is about as likely to be allowed to start a newspaper or magazine on the mainland today as, say, the head of Falun Gong.
The demise of Hong Kong as China's gateway is far from proven. The number of multinationals with regional headquarters in Hong Kong, mostly to handle China business, rose 20% last year. And Taiwan is nobody's idea of an international financial center. Yet there are strong business affinities between Taiwan and the mainland, ranging from language and business methods to Taiwan's strengths in high technology. Officially, Taiwan has invested $26 billion in China, but the real figure could be two to three times as large. (Because of Taiwanese laws limiting the kinds of business that can be done in China, much investment is in a legal gray zone and thus difficult to track.) Nevertheless, Taiwan is investing in everything from high-profile projects like a $1.6 billion joint- venture chip factory in Shanghai to opening branches of well-known Taiwanese beauty salons. More and more Taiwanese think their economic future is with the mainland: Hanson Cheah, the Hong Kong venture capitalist, says that a few years ago mainland-based companies would have to pay Taiwanese executives double their Taiwan salaries to work on the mainland; now the differential is down to 40%.
Looming over everything, though, is politics--what McGregor calls the "Achilles' heel in China." Even if a more modern political outlook and a more internationally savvy generation of leaders is on the way, a difficult transition must be negotiated before they arrive. Within two years most of the top leadership--including President Jiang Zemin and Premier Zhu Rongji--will be replaced, their terms of office having expired. The broad outlines of economic reform may be almost universally accepted, but in a country whose institutions are as weak as China's, it makes a lot of difference who is actually wielding power.
Another aspect of the political quandary has to do with how China relates to the rest of the world. The incident in April when the Chinese detained the crew of an American spy plane after its midair collision with a Chinese fighter jet was only a taste of the increasingly prickly situations that will arise in coming years as China begins to challenge America's geopolitical dominance in East Asia. Tai Ming Cheung, an expert on the Chinese military who is a risk advisor for PricewaterhouseCoopers in Tokyo, thinks that China's aim over the next five to ten years is "to develop strategic capabilities commensurate with their economic power. They want to limit America's voice on security issues in the region." The Chinese military, he says, thinks that within this period it will develop enough resources--often by buying them from the Russians--to counterbalance America's carrier battle groups and bases in Japan and South Korea. If you thought the spy plane incident was nasty, wait until the Chinese get stronger and start challenging America's military presence in the region more assertively.
The issue of Taiwan makes this likely conflict downright ominous. China's strategic ambitions in East Asia may be containable; its insistence that Taiwan is part of China is not. Nobody who watches China has any doubt that if it felt Taiwan was truly slipping from its grasp, China would sacrifice all its wonderful economic prospects to keep that from happening. In one sense, time is on the side of a peaceful resolution of this obdurate question--a freer and more open China in, say, 20 years would be a less repellent and maybe even attractive suitor for Taiwan. But in a more immediate sense, the clock is ticking toward a showdown.
The Chinese army is much more focused on the issue of Taiwan than it was even five years ago, says Tai Ming Cheung. The generals fear that the election of Chen Shui-bian, once a pro-independence advocate, as Taiwan's president last year, was a sign Taiwanese people were identifying themselves less and less with the mainland. They also fear that if Taiwan keeps getting advanced weapons from America, it will, by the time this decade is out, be in a position to resist a Chinese assault. For the hawks, those are strong arguments for pretty fast action--such as invading or otherwise bringing Taiwan to heel by force.
So, yes, China may be on its way to the greatest economic rise in modern history. But an old-fashioned war over a small piece of land could still stop it dead.
