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Volume 2, Number 2 in Global TECHtonics: U.S./China Fault-line series

 

One of the most memorable moments from the two months of A-100 training I received upon entry into the U.S. Foreign Service was a leadership training film about the 1985 Bradford City Football (Soccer) Stadium fire.  A small fire, sparked in a code-violation trash pile, was quickly whipped by winds into a fire engulfing substantial portions of the stadium. The raging fire trapped spectators, killing 56 and injuring at least 265.

Filmed on-site during the panic, the key point in this very graphic film involved the challenge of communications in a crisis.  As described by Wikipedia, “In the mass panic …, fleeing crowds escaped on to the pitch but others at the back of the stand tried to break down locked exit doors to escape, and many were burnt to death at the turnstiles gates, which had also been locked after the match had begun.” The specific problem was that people at the front of the mass of people trying to flee from the gates quickly recognized that those gates were locked but, in the panic, could not communicate the problem back to the people pressing forward from behind.  Had clear communication been possible, everyone could have found an alternative exit. As it was, scores of people ended up pinned against the gates and perished.

The lesson for the U.S.-China technology upheaval currently underway is straightforward: the implications of the upheaval appear different to different parties, depending upon their position in the field of action, and there is danger of differing reactions and poor communications compounding the danger and likewise leading to tragedy.

The goal of this post is to set out in very general terms the different industry groups affected by the Trump Administration’s efforts to date to “decouple” the U.S. and Chinese tech spheres – denying various sub-sectors of the Chinese tech industry access to the U.S. market, incentivizing U.S. firms to bring their production from China back to the U.S., and also encouraging allied governments to reinforce both approaches.  There are four major technology sub-sectors that, to date, have been affected by these policy moves.  In addition to providing simple, thumbnail descriptions of each of these four sub-sectors and how they have been affected by the Trump Administration policy approach, we will also rank them in terms of national security risk and look at the potential for a seismic reaction being triggered.

A simple way of assessing national security risk and gauging the related potential for a Bradford Stadium-type chain of events is to think in terms of crisis management.  Crisis management experts generally identify four distinct stages as a true crisis develops. The following is drawn from the Crisis Prevention Institute’s Crisis Development Model:

  1. Anxiety

Anxiety prompts changes in behavior and looking at things differently. It’s a time to listen and observe, not dictate what should happen next.

  1. Defensive Behavior

Defensive behavior can be a natural escalation of anxiety; it’s the point where actors in crisis begins to lose rationality.

  1. Risk Behavior

Risk behavior is displayed as actors enter crisis and reach the point of propensity to harm themselves or others.

  1. Tension Crisis

Every crisis reaches a point of meltdown or tension reduction. Crisis behaviors, as they escalate, expend a tremendous amount of energy.

So here we go …

 

 

Level One

Among the earliest Trump Administration actions targeting technology products from China involved the use of tariffs.  While the various rounds of tariff actions are too technical and convoluted to get into here, a few broad generalizations can be made.  First, the tariff actions put into effect were more targeted to electronic components than to finished electronic consumer products.  For instance, componentry for modems, routers and televisions were subject to two rounds of steep tariff increases and microelectronic chips were assessed a hefty 25% tariff while consumer products such as cellphones, laptops and video games, despite a series of threats by Trump to impose tariffs in the summer and fall of 2019, have still not been hit with any tariffs to date. The President’s advisors apparently convinced him, as the Christmas season approached, that voters would not take kindly to sudden price increases for these products. Second, there is little evidence to suggest that these tariffs inflicted enough pain on Chinese technology manufacturers and exporters to induce them to substantially change their behavior or to protest loudly to their government for relief.  Tariff increases can be absorbed at any link in the supply chain stretching from the manufacturer and its supplier network (in China) to the importer, distributor and retail outlet (in the U.S.) or, alternatively, can end up simply be passed on to the consumer (in the U.S.).  Preliminary analysis indicates that the U.S. side of the supply chain in technology products has likely absorbed as much pain from these rounds of tariff actions as the Chinese side has been forced to absorb.  Third, tariffs are the quintessential sledgehammer used to crack open a peanut.  Even if they actually hit the peanut, it tends not to yield anything worth the effort and can cause considerable damage to the surroundings.

At the same time that the Trump Admistration was rolling out waves of tariffs to target imported goods from China, they were also tightening and expanding limits on investment into the U.S. by Chinese technology companies – as well as certain other types of companies – on the grounds that they represent a risk to U.S. national security.  The mechanism for achieving this was through expansion of the review powers of the Committee for Foreign Investment in the United States (CFIUS), an inter-agency body comprising nine cabinet-level departments and chaired by the U.S. Secretary of the Treasury.

As with the tariff actions, the heightened scrutiny of potential Chinese investments into the U.S. by CFIUS served primarily to send a political signal to the Chinese side that the commercial and economic climate was getting chillier for Chinese companies in the U.S.  Chinese companies looked for work-arounds, adjusted their business plans, and in some cases looked to other world markets to take up the slack.  These two sets of actions caused some tremors but did not cause the ground to fundamentally shift under U.S.-China relations.  This represented, broadly speaking, the Anxiety Phase of the building crisis.

 

Level Two

The first indication of a second, potentially more consequential level of tension occurred in the spring of 2018, as President Trump was repeatedly threatening to levy tariffs on China  but before the imposition of the first round of tariffs in July of that year.   That second front involved Shenzhen-headquartered ZTE, one of China’s largest makers of smartphones and telecommunications equipment. In March, two ZTE affiliates agreed to a civil and criminal penalty of $1.19 billion for having illegally shipped telecommunications equipment to Iran and North Korea.  Two months later, after it was found out that ZTE had failed to reprimand and had, in fact, paid bonuses to the executives involved in those illegal shipments, a seven-year ban on the export of U.S. components to supply ZTE’s manufacturing facilities in China was instituted.  This ban was widely viewed as a likely ‘death sentence.’ The manufacture of ZTE smartphones would not be possible without access to U.S.-made microelectronic hardware and Android operating system software.  Moreover, the fact that ZTE had been designated as a risk to U.S. national security hung like a sword of Damocles over the country’s future.  But, almost immediately, the sentence was lifted without clear explanation.  On May 13th, President Trump tweeted “President Xi of China, and I, are working together to give massive Chinese phone company, ZTE, a way to get back into business, fast. Too many jobs in China lost. Commerce Department has been instructed to get it done.”  One week later, the U.S. Commerce Department eased the restrictions and on June 7th a deal was reached whereby the Chinese company agreed to complete a $400 million escrow payment in return for the complete lifting of the seven-year export ban.

The whole sequence of events was somewhat baffling except for what it indicated about President Trump’s penchant for injecting himself personally into company-specific matters and for taking public and dramatic steps to build his rapport with President Xi.  There is widespread speculation that Trump hoped, through this off-again on-again  courtship of Xi, that he would get a trade deal which would allow for the lifting of the whole raft of “Level One” tariffs and give him a major trade deal to tout in the run-up to the 2020 elections.

It was not to be.  U.S. and Chinese trade negotiators continued to slog through their negotiations inconclusively and an apparently frustrated Trump and the U.S. national security apparatus soon turned their attention to an even larger target than ZTE–Huawei, China’s national champion in that industry space.  Founded in 1987 by Ren Zhengfei, a former army officer, and also headquartered in Shenzhen, Huawei employs 200,000 and manufactures telecommunications equipment, particularly equipment used in the infrastructural backbone of the new 5G standard for telecom, and consumer electronics, particularly smartphones.  As was the case with ZTE, the Trump Administration voiced a specific legal concern and general national security concern in launching its campaign against Huawei.  The legal matter concerned charges that Huawei too had created elaborate corporate structures to evade the U.S.-led “maximum pressure” sanctions regime against Iran.  Specifically and most visibly, that legal issue crystallized around the detention in Canada of Ren’s daughter and Huawei CFO, Meng Wanzhou in early December 2018.  The charges, unveiled publicly by the U.S. Justice Department in late January 2019, alleged a decade-long attempt by Huawei and Meng to steal trade secrets, to obstruct a criminal investigation and to evade economic sanctions on Iran.  Canada was asked to extradite Meng to the U.S. to face trial on these charges.

The broader national security issue behind the campaign against Huawei centered on the charge that the Chinese government would be able to get access to the torrent of data coursing through next generation 5G telecom networks.  To the extent that Huawei-supplied network components are built into the backbone of those networks, Huawei could gain access to the data. And, the thinking goes, that since Huawei is a China-based, PRC-supported champion company, Huawei would have no ability – protestations by the founder and company spokespeople to the contrary – to resist Chinese government requests for access to that data.

The two characteristics of the still on-going U.S. government-led campaign against Huawei which sharply distinguish it from the earlier actions against ZTE are its long duration and its expansion to the international field.  Each one of these two characteristics presents complexity which defies easy summarization.  Future posts will examine the international dimension of this campaign which has brought the Trump Administration some hard-won headway but also a sometimes stunning level of push-back and public repudiation from traditional allies.

For now, the point is simply that the initial evanescent campaign against ZTE and now the sustained campaign against Huawei can together be thought to represent the second level of effort, and risk, in forcing U.S.-China tech decoupling.  Representing a natural escalation of the anxiety provoked by the various tariff rounds, these two sets of actions – and, particularly, the Huawei campaign — reveal factors of irrationality coming into play.  On the Chinese side, the issue is a personal affront to Xi Jinping.  It is also catnip for the millions of Chinese “netizens” who use nationalistic vitriol and memes to inflame public opinion which, in turn, further narrows the options available to Xi and his government policy makers.  On the U.S. side, Trump Administration officials have tried to cajole other countries into raising their own costs and slowing their own transition to 5G by foregoing Huawei equipment without providing specific evidence of the claimed threats to help countries justify taking these steps.  Domestically, the Administration has failed to provide a clear rationale and consistent messaging so that the public can assess the risks.  Instead, the Administration has framed the issue in terms that are highly personalized to Trump and in a tone that is more macho than rational.  It has become, in effect, a bullet point in Trump’s “I’m tougher on China than Sleepy Joe will ever be” reelection strategy.

The factor which has perhaps kept these actions from destabilizing U.S.-China relations even more is that the U.S. doesn’t have its own horse in the 5G sweepstakes.  The two major competitors to Huawei are Ericsson (Sweden) and Nokia (Finland).  The fact that European allies have been so reluctant to sign on to the U.S. campaign against Huawei, even though two major EU companies stand to gain competitively, underlines just how weak the national security case which Trump officials put forward has been.  Over recent months, as the campaign has made some headway following an initial and embarrassing series of stalls out of the gate, Samsung  (Sourth Korea) has also emerged as a potential provider of 5G telecom infrastructure components.

 

Level Three

 

A third, but more nascent, level of conflict is now beginning to take shape around social media networks and search engine companies.  The players at center-stage of this now emerging drama are the tech giants:  Apple, Google, Facebook, Amazon and Microsoft in the U.S. and Baidu, Alibaba, and Tencent (the so-called ‘BAT’ trio) and Bytedance in China.  For U.S. readers not familiar with the commercial landscape in China, Baidu, the weakest of the trio, makes money, somewhat like Netflix, principally through advertising and content subscription services built around its Baidu search engine.  Alibaba, the strongest of the trio, operates a vast Amazon-like selling site for both business (B2B) and consumer (B2C) end-users.  Leveraging extraordinary global reach and profitability with this base of operations in e-commerce sales and delivery, the Alibaba family of companies is increasingly branching into business areas as diverse as cloud computing, media and entertainment, microfinance and tourism.  Tencent is the owner of WeChat, a multi-purpose messaging, social media and mobile payment app which has achieved far greater penetration in the Chinese market – and has become more of an indispensable feature in the lives of its users — than any comparable app has achieved in the U.S.  Bytedance is the owner of the massively popular TikTok app.

The market access picture for U.S. firms in China has been markedly less open than that traditionally enjoyed by the above Chinese firms in the U.S.  Put simply, there has not been reciprocity and the U.S. Big Five Tech Giants have long faced restrictions limiting their ability to do business in China.  This is a direct reflection of the Chinese government’s sensitivity, verging on paranoia, about its citizenry’s ability to access sources of information beyond the government’s control.  (The three pillars of control for the Chinese Communist Party (CCP) have been, even before assuming control of the nation in 1949, the so-called Three P’s – the Party, the PLA (People’s Liberation Army) and Propaganda).  Of the five U.S. companies, Apple’s iPhone and Microsoft’s personal computers and LinkedIn business networking service have enjoyed relatively freer access to the Chinese market, though that access is nonetheless significantly constrained. Microsoft, which has had a presence in China since 1992, has fared the best.  Its operating system controls more than a third of the market in China and through its research center in China (its second largest in the world), Microsoft works closely with major Chinese companies on innovative product development. Apple has enjoyed some access for its iPhones, however, the iPhone’s penetration has been limited in China by its high price-point and positioning as an aspirational brand undercut in price by Huawei and Xiaomi.  The other three companies have been largely shut out of the market: Google by its refusal to accede to demands, explicit and implied, to make search results and other data available to the Chinese government; Facebook has flatly failed to get government permission to operate in the Chinese market despite years of personal lobbying by Mark Zukerberg (which included Zuckerberg learning Mandarin, recommending Xi Jinping’s book to his employees and even asking Xi Jinping to suggest a name in Chinese for his baby); and Amazon, which faced stiff price competition from Alibaba and JD.com, decided in early 2019 to shut down its uphill effort to build an e-commerce marketplace business in China.

While fierce competition is an undoubted factor in explaining some of this picture of limited presence by the U.S. tech giants in China, government policy is the paramount issue.  As previously mentioned, an overriding element of the government’s restrictive policy has to do with control over information.  An additional element has to do with the government’s drive – also seen in the aerospace and financial sectors – to give homegrown companies a protected space to grow domestically in order to develop into global competitors and foreign exchange earners.  That this is inconsistent with commitments which China made upon entry into the WTO in December 2001 is a cause of concern for the global community.  That it creates an unequal playing field for U.S. firms in China is a common concern shared by both political parties in the U.S. and needs to be addressed.  That there is evidence of Chinese firms using their penetration of the U.S. market to conduct unauthorized data collection from U.S. citizens is even a greater matter of concern, one that demands strong and strategic counter-measures.

On this last point, it is an established and publicized fact that WeChat has been used to collect data from the devices of U.S. citizens on U.S. soil without the individual’s or the U.S. Government knowledge and, of course , without any legal authorization.  Any and all information on a compromised device is at risk in these instances. The pattern of known instances of compromise suggests strongly that there has been a directed campaign by the PRC at work rather than a series of random or accidental intrusions by Tencent. Substantially more information on this vulnerability is known within U.S. government circles than has been shared to date through public sources.

It is this type of vulnerability which is the behind the Trump Administration’s announcement on August 6th of this year of signed Presidential orders to ban commercial transactions with WeChat’s parent company, Tencent, and with Bytedance, Tiktok’s parent.  The fact that 60% of users of the TikTok platform are under the age of 24 make it seem, at first blush, to be an unlikely target for PRC government-directed surveillance. But closer inspection shows that risks are not negligible.  There is the established precedent from WeChat.  There is the vast user base – 85 million in the U.S and 1 billion worldwide.  Also, as any expert will tell you, surveillance and espionage seek to exploit any vulnerability and one’s children can be a significant vulnerability.  Finally, younger people are disproportionately represented in the workforce of some of the most innovative and cutting-edge industries.

I will have occasion in the future to post on several aspects of this emerging arena of U.S.-China conflict.  One topic involves the “geo-commercial” advantage which China enjoys with its population size, its unmatched number of smart-phone users, and its lax privacy laws, standards, and public expectations.  As a result of these factors, Chinese companies are able to develop algorithms for new products and services more effectively and efficiently than their competitors.  Bytedance’s TikTok is itself an example of this phenomenon.  A second topic will be ‘balkanization’ of the Internet which will accelerate as the U.S. and China continue to de-couple and de-globalize their tech interests.  A third topic will be the decisive role which India is likely to play in this contest as it balances its position as a massive market for cut-rate, Chinese-made smart-phones and as an important English-language strategic partner for Facebook and other U.S. social media and internet content and service providers.

For now, we can wrap this section with the observation that this emerging front in U.S.-China tech de-coupling involves a unique level of risk.  It is so entwined in the lives of so many users and it touches on the core interest of so many behemoth companies in both the U.S. and China that it is markedly different from the risks found on the ZTE and Huawei front.  While we are likely just in the early days of this new sphere of competition, it brings the U.S.-China relationship  clearly into the third, risk behavior phase of the crisis development cycle. As this front continues to become a focal point, the public attitude and corporate bottom-line interests at stake are so core that entry into a mutually-destructive cycle of action and counter-action is almost foreordained unless both sides exercise great discernment and discipline.

 

 

Level Four

In last week’s post, Timing Matters, we touched on the issue of supply chains for semiconductors and advanced electronics.  Because these products are the ‘brains’ behind entire emerging industries – artificial intelligence and robotics, autonomous vehicles, the commercialization of space, and others – this is where the United States’ and China’s economic competition is most fierce.  Because these supply chains inextricably pass through Taiwan and Taiwan-headquartered industry leaders like TSMC – the economic risk is compounded by political risk.

The Assessing China ”Global TECHtonics: U.S./China Fault-line” series will delve much more deeply into this issue in the months ahead.  Suffice it to say for now, that microelectronics and the global supply chains which help produce and distribute semiconductors and related products globally will be the fault-line which either ends up triggering a cataclysmic upheaval between the U.S. and China or, through inter-governmental negotiation, helps to settle the entire relationship on a new, more stable and sustainable basis.

 

Crackdown or Startup w border

 Henry “Hank” Paulson — former Chairman of Goldman Sachs, former Secretary of the U.S. Treasury and creator of the U.S.-China Strategic & Economic Dialogue — was in Philadelphia last Wednesday.  He came to publicize his new book Dealing With China: An Insider Unmasks the New Economic Superpower.

The media frame for the talk and Q&A which he gave to the World Affairs Council of Greater Philadelphia was:  ‘Hank, you’re a real patriot. Why are you helping China?”

In response, Hank Paulson was very clear that his interest in promoting a better understanding of China is rooted in his desire to do what is best for America.

You can read the full article here but, for the purposes of this post, I’m going to focus on one small, but important, piece of the big contemporary China puzzle:  Is Xi’s ongoing crackdown (on corruption but also on foreign businesses, NGOs, press freedoms, social media, connectivity to the global knowledge-pool, etc) flashing green, yellow or red for China’s paramount challenge of rebooting its economy on a more sustainable basis?

China’s ‘old software version’ of infrastructure build-out, inbound investment and export of cheap stuff is clearly no longer operating smoothly on the new global hardware system.  China’s future – and Xi Jinping’s for that matter – depends on a smooth updating to a ‘new software version’ of consumer-led spending, outbound investment and innovation up the product value-chain.   Under any circumstances, that’s a tall-order to pull off in just a few years.  For those of us who believe that helping China matters to America’s future, the key question is whether the crackdown on political thought in China is – or is not — inimical to the desperately needed surge of commercial innovation needed to upgrade China’s economy to version 2.0.

It is perhaps not entirely a coincidence that, in the same week that Hank Paulson was wrestling with this question in Philadelphia, so were two other leading experts on the trajectory of China’s globalization elsewhere:  Shaun Rein and Tom Friedman in respective articles.  If Hank Paulson occupies the pivot point as a U.S. patriot committed to helping China, Shaun Rein is a self-acknowledged China booster and Tom Friedman a “color me dubious” observer of China’s steep road ahead to globalization.

Here’s what each of them has had to say over the past week on the ‘sword of Damocles’ question facing Xi and China:  crackdown or start-up?  (Click on the name below in order to source the original publication from which the following excerpts are taken):

Hank Paulson

Paulson

“Paulson believes the Communist Party has reached a simple accord with the Chinese people: prosperity in return for continued state control. The question, of course, is whether China can have it both ways – economic freedom without cultural freedom, a subject I raised with Paulson at the World Affairs Council.

‘In today’s information economy, I don’t know how economies can innovate and do the sorts of things they do to stay on top without having a free flow of ideas and information,” Paulson replied. “I’ve run a global company, and, boy, you need to be connected. You can’t have an Internet that’s not connected. You need to know what’s going on politically, regulatory systems, economically, in terms of ideas all over the world.’

He added: ‘But understand what’s going on right now. Xi Jinping . . . is focusing on the things that the people care about the most. So, corruption. He recognizes the party won’t survive unless he curbs corruption. So he’s focused on corruption, the environment, dirty air, and water.’

“So . . . managing China, just think what it’s like because they have to deal with the kinds of issues that afflict developed countries at the same time they have to deal with issues that developing countries are dealing with because a big part of the country is still poor. It would be like, . . . looking at Europe, Germany and Slovenia. They are both European, vastly different stages of development, they need different economic policies. So think about managing both of those in a single country under one party, and I mean that’s sort of the challenge.’”

 Shaun Rein

rein-circular

“China´s much needed anti-corruption drive has now put the country into a lock-down mode, and new projects have halted,” tells business analyst Shaun Rein at CNBC.  “The cut in the reserve ratio ratio (RRR) this weekend is one way for a kickstart, although nobody know what will really work.”

 China Herald:  “What does the Chinese market need to stimulate the economy and if this growth continues to disappoint then would you expect an additional benchmark rate cut in the next couple of quarters, something that many experts are now talking about?”

Rein:  “I think what we need to look at is not gross domestic product (GDP) growth but we need to take a look at unemployment and the second reason why I am more concerned about the economy is in the last month urban unemployment has been hovering around 5 percent – that’s really a problem. So the unemployment rate in areas of manufacturing are still fairly strong and you can easily stimulate that by forcing state owned enterprises to do heavy investment; train construction, airport construction and you can get jobs there but the issue is urban unemployment is weak and there aren’t a lot of easy remedies. The government is trying to switch from manufacturing oriented economy more towards one of technology and innovation as I outlined in my new book ‘The End of Copycat China’ but it is not easy to do that. You cannot get companies that are producing things all a sudden to become innovators, so there is definitely going to be some weakness, some problems in the economy over the next three-four months and frankly there are no easy answers on how they stimulate the economy.”

Tom Friedman

friedman-circular-thumbLarge-v3

“Americans … are asking of President Xi: “What’s up with you?” Xi’s anti-corruption campaign is clearly aimed at stifling the biggest threat to any one-party system: losing its legitimacy because of rampant corruption. But he also seems to be taking out potential political rivals as well. Xi has assumed more control over the military, economic and political levers of power in China than any leader since Mao. But to what end — to reform or to stay the same?

“Xi is “amassing power to maintain the Communist Party’s supremacy,” argued Willy Wo-Lap Lam, author of “Chinese Politics in the Era of Xi Jinping: Renaissance, Reform or Retrogression?” Xi “believes one reason behind the Soviet Union’s collapse is that the party lost control of the army and the economy.” But Xi seems to be more focused on how the Soviet Union collapsed than how America succeeded, and that is not good. His crackdown has not only been on corruption, which is freezing a lot of officials from making any big decisions, but on even the mildest forms of dissent. Foreign textbooks used by universities are being censored, and blogging and searching on China’s main Internet sites have never been more controlled. Don’t even think about using Google there or reading Western newspapers online.

“But, at the same time, Xi has begun a huge push for “innovation,” for transforming China’s economy from manufacturing and assembly to more knowledge-intensive work, so this one-child generation will be able to afford to take care of two retiring parents in a country with an inadequate social-safety net.

“Alas, crackdowns don’t tend to produce start-ups.

“As Antoine van Agtmael, the investor who coined the term “emerging markets,” said to me: China is making it harder to innovate in China precisely when rising labor costs in China and rising innovation in America are spurring more companies to build their next plant in the United States, not China. The combination of cheap energy in America and more flexible, open innovation — where universities and start-ups share brainpower with companies to spin off discoveries; where manufacturers use a new generation of robots and 3-D printers that allow more production to go local; and where new products integrate wirelessly connected sensors with new materials to become smarter, faster than ever — is making America, says van Agtmael, “the next great emerging market.”

“It’s a paradigm shift,” he added. “The last 25 years was all about who could make things cheapest, and the next 25 years will be about who can make things smartest.”

President Xi seems to be betting that China is big enough and smart enough to curb the Internet and political speech just enough to prevent dissent but not enough to choke off innovation. This is the biggest bet in the world today. And if he’s wrong (and color me dubious) we’re all going to feel it.”

by Elizabeth C. Economy

February 6, 2015

A book vendor reads a book as he waits for customer next to portraits of Chinese President Xi Jinping (L) and late Chairman Mao Zedong, at an open-air fair in Juancheng county, Shandong province January 30, 2015. REUTERS/Stringer (CHINA - Tags: SOCIETY POLITICS) CHINA OUT. NO COMMERCIAL OR EDITORIAL SALES IN CHINA
 ( Photo: Stringer/Courtesy Reuters).

As Xi Jinping nears the two-year mark of his tenure as president of China, he might want to take stock of what is working on the political front and what is not. Here are some early wins and losses.

Certainly, his anti-corruption campaign has hit its target—hundreds of thousands of them to be exact—and shows little sign of slowing down. He has cast a wide net, leaving little doubt that no sector of society—party, military, business, or other—is completely safe. Still, Xi remains vulnerable to accusations that the campaign is at least partially politically motivated, given that almost half of the senior-most officials arrested are tied in some way to his political opponents, and none of his Fujian or Zhejiang associates have been detained. He might want to bring some transparency to the process: uncertainty and fear of running afoul of some regulation or another are driving many officials to avoid making decisions or taking action.

Xi’s ideological war has also taken hold far more rapidly than anyone might have imagined. The Internet as a forum for lively political discourse has virtually closed down, and his crack team of propagandists are constantly coming up with new ideas to turn back the information age for the average Chinese citizen. Banning foreign textbooks, blocking Gmail and VPNs, and putting cameras in classrooms to report on professors are just some of the initiatives underway. It is hard to reconcile Xi’s desire to support China’s most creative and innovative thinkers—much less attract back those who have made their lives abroad—to jumpstart the economy with policies designed to block communication and access to information. If he doesn’t reign in the Liu Yunshan’s and Lu Wei’s soon, he should probably expect a wave of China’s best and brightest to get their passports in order.

Xi has had less success in his efforts to reform social policy. Perhaps nothing is as surprising as the failure of the relaxation of the one-child policy to encourage young Chinese couples to have more children. In late 2013, Beijing issued new rules that permitted couples to have a second child if either parent was an only child. The government saw relaxation of the policy as a win-win—addressing both a significant source of societal discontent as well as the challenge posed by an aging population and shrinking labor force. Initially, the government estimated that with the reform, approximately eleven million additional couples would be eligible to have a second child. They anticipated that roughly two million new babies would be born each year. Instead, only one million couples applied, and as one Chinese expert estimates, there have been only 600,000 to 700,000 newborn second babies—roughly one-third of what the Family Planning Commission had anticipated. Analysts suggest that there are a number of reasons for the baby shortfall: no preschool for children under three, toxic environmental conditions, economic concerns, and even too much success in inculcating the value of a one-child policy.

Reform of the hukou, or residency permit, system is struggling as well. Launched in July 2014, hukou reform technically allows migrant workers to establish residency and receive benefits, such as education for their children, in the cities in which they work. Yet restrictions in the plan mean that only a small percentage of the more than 200 million migrant workers will likely benefit from the policy. Cities such as Beijing, Shanghai, Chongqing, and Guangzhou, which are home to the largest numbers of migrant workers, are excluded from the policy. Indeed, the new regulations only permit migrants to receive full urban residency benefits if they move to towns and cities of less than 500,000. Cities in between 500,000 and the most popular megalopolises have a range of restrictions on their residency requirements. As Chinese demography expert Kam Wing Chan has noted, it makes no sense to exclude the largest cities or set the barriers too high in other large second-tier cities—that is where most migrant workers currently live and, most importantly, where work is available. Given current restrictions in the policy, Chan estimates that to bring the migrant population to zero—the objective of the reforms—will require three to four more decades.

Policy reform is challenging under any circumstance, but all of Xi’s reforms share a common problem: a fundamental misunderstanding of social dynamics. The lack of restraint in the anti-corruption campaign and ideological war create a climate of fear that will undermine success in achieving other policy objectives over the long term, while a failure to recognize the actual needs of young Chinese couples and migrant workers means that the one-child policy and hukou system reform will continue to deliver sub-optimal results. For Xi Jinping it may well be time to reform his reforms.

Premise

Participation in China’s fast-growing nuclear market offers promise and peril for global market-leaders.  A model coupling U.S. innovation with Chinese scale and speed of deployment offers the best path forward.

Discussion

The development of China’s nuclear market has been driven by a governmental elite, many of whom were trained as engineers. Their strategic thinking appears to be motivated in part by the challenges of climate change – to adopt lower carbon sources of electricity generation. As the vice president of the China Nuclear Energy Association has pointed out, nuclear power – rather than solar, wind or biomass – is “the only energy source that can be used on a mass scale” to achieve clean, low-carbon energy.

Just as significantly, though, China’s rapid expansion of nuclear power appears motivated by a desire to upgrade the Chinese nuclear industry by enticing foreign suppliers who want to participate in China’s market growth to share their technology with Chinese partners. The profit potential is vast in China, but other big emerging economies, such as India and Brazil, will be exploring nuclear installations in coming decades. To wrest some of that business away from established incumbents –such as France’s Areva and Japan’s Westinghouse – China is leveraging its low-cost labor and deep experience with major infrastructure projects. A Western-designed reactor can be built in China for 40% less cost and 36% faster than that same installation in Europe.

For China to become globally competitive its two major nuclear power companies — China National Nuclear Corporation and China Guangdong Nuclear Power Group — will need to improve in the knowledge-intensive end of the business. Of the 13 nuclear power plants currently operating in China, only three — all at the Qinshan site — rely on an indigenously developed design. Likewise, China has only limited experience selling its reactors in export markets; Pakistan is the only known foreign buyer to date. Finally, to compete globally, China will need to manufacture specialized components, for which it is currently dependent on foreign suppliers.

As for U.S.-China strategic cooperation in the nuclear field, there have been important undertakings but, to date the governments have not attempted anything on a broad strategic basis. There are interesting opportunities on the horizon. Former U.S. Ambassador to China, Jon M. Huntsman Jr., has reported discussing with Bill Gates a new kind of reactor “that runs for decades on a single fuel load, making and destroying plutonium as it runs,” thereby reducing the hazards of reprocessing and the dangers of proliferation. According to Huntsman, strategic cooperation between the U.S. and China to develop this American-pioneered technology could bring shared benefits. The technology could, for example, be certified and brought to commercial scale faster in China. A partnership effort could be envisioned where a joint American-Chinese company leads the construction, with co-development and commercialization rights apportioned between the partners. The end-result could be a cleaner and (marginally) safer form of energy brought to consumers quickly and at scale.

(This piece has been reprinted from G+ Insights, a publication series of the Gerson Lehrman Group at www.gplus.com.  The G+ piece, in turn, has been adapted from Sustaining U.S.-China Cooperation in Clean Energy,  a book publication authored by Terry Cooke forthcoming from the Kissinger Institute of the Woodrow Wilson Institute in November 2011).

Premise

The Fukushima disaster in March has prompted all major nuclear powers to pause and reexamine their nuclear development programs. Germany and Italy reached decisions to phase out their nuclear programs.  In the U.S., stirrings of interest in a nuclear revival were silenced.  In China, however, all indications are that a national program to establish China as a global leader in nuclear power remains on track.

 Discussion

The first commercial nuclear power plant in the U. S. was installed in 1958. Today, 104 commercial reactors produce almost 20% of the nation’s total electric generation. By comparison, China’s first nuclear plant, Qinshan, near Shanghai, became operational in 1991. Today, 13 plants are in operation supplying just over 1% of China’s total electricity. However, this freeze frame comparison misses the contrast in momentum for the nuclear industry in the two countries. Of the 52 nuclear power plants that were either under construction or in advanced planning in America and China in late 2010, months before the Fukushima disaster, 50 of those plants were being planned and built for the Chinese market.

source: U.S. Energy Information Administration

As the above chart from the U.S. Energy Information Administration shows, nuclear generation has plateaued  in the U.S. and Europe but is rapidly growing  in China, India and the rest of the developing world. While active plants in the U.S. are approaching the end of their licensed lifetime without planned replacement,  new nuclear installations in China are set to increase roughly ten-fold over the next ten years.

Following 1979’s Three Mile Island incident, the experience for the U.S. nuclear industry has been new order cancellation, new construction abandonment, premature shutdown of plants or extension without plans for replacement. Although improved design and technology advances have brought about significantly improved safety performance, public opposition to nuclear power — periodically galvanized by highly publicized international incidents such as Chernobyl and Fukushima and persistently bedeviled by the nuclear waste disposal problem– has kept the U.S. market virtually off-limits to new nuclear installations for three decades. China, by contrast, is the world’s most active site for new plant installations. National planning calls for nuclear power to provide 6% of China’s total electrical generation by 2020. This will require a net increase in installed capacity of 60-70 GW, comparable to the entire 63GW of currently installed nuclear capacity in France, one of the world’s most active users. By 2030, China plans to match the nuclear output currently provided by all 104 U.S. installations.

The bottom line:  Chinese authorities clearly know how to throttle back a prestige industrial development project, as shown after July’s high-speed train collision in Zhejiang Province.  After the Fukushima nuclear disaster, however, no such bureaucratic braking of China’s nuclear program has been apparent.  Additional safety reviews have been instituted, but the scale and speed of China’s nuclear program remains essentially unchanged.

 

(This piece has been reprinted from G+ Insights, a publication series of the Gerson Lehrman Group at www.gplus.com.  The G+ piece, in turn, has been adapted from Sustaining U.S.-China Cooperation in Clean Energy,  a book publication authored by Terry Cooke forthcoming from the Kissinger Institute of the Woodrow Wilson Institute in November 2011).

 

The following post was co-authored by Shawn Lesser (Watershed Capital Group) and me and appeared initially on the Cleantechies blog:

A number of the cleantech efforts between the United States and China reflect the need for cooperation on issues surrounding climate change and clean energy as it is a major factor in the relations of these two countries. Although there are still issues to resolve in many of the collaborations, it is believed that if the United States and China can continue in their cleantech collaborations, that it will show the world that two major players on the international platform are serious about combating the challenge of climate change, and it will also encourage other countries to create alliances. Through collaboration, the two largest greenhouse gas emitters will be able to create technologies required to combat climate change. Not only that, but tangible benefits will be developed, not just for the United States and China, but the world as a whole.

1) United States – China Ten Year Framework for Cooperation on Energy and Environment was established in 2008, and it “facilitates the exchange of information and best practices to foster innovation and develop solutions to the pressing environment and energy challenges both countries face.” It also led to the creation of “EcoPartnerships” – a way to encourage both United States and Chinese stakeholders to strengthen their commitment to sustainable economic development within the local level.

2) United States – China Clean Energy Research Center (CERC) has its main headquarters in both countries. It will facilitate research and development of technology by a team of leading scientists and engineers in the clean technology industry. The research center receives both private and public funding which is split evenly for each country. The initial research priorities of the United States – China Clean Energy Research Center includes building energy efficiency, clean vehicles, and clean coal, which includes carbon capture and storage. It was founded in 2009 by United States President Barak Obama and Chinese President Hu Jintao. The goal of the research center is to “build a foundation of knowledge, technologies, human capabilities, and relationships in mutually beneficial areas that will position the United States and China for a future with very low energy intensity and highly efficient multi-family residential and commercial buildings.”

3) United States – China Energy-Efficient Buildings (CERC-EEB) Action Plan enables the United States and China to work alongside the private sector in an effort to develop energy efficient rating systems and building codes, benchmark industry energy efficiency, provide training to building inspectors as well as energy efficiency auditors at industrial facilities, synchronize test procedures and performance metrics for consumer products that are energy efficient, exchange energy efficient labeling systems best practices, and assemble a new annual United States – China Energy Efficiency Forum. The action plan will be achieved through green building and communities, industrial energy efficiency, consumer products standards, advanced energy efficiency technology, and public and private engagement.

4) United States – China Electric Vehicles (CERC-EV) Initiative builds upon the previous United States – China Electric Vehicle Forum which was held in 2009. The initiative comes from the shared interest in increasing the utilization of electric vehicles to decrease oil dependence and greenhouse gas emissions, while promoting viable economic growth. This initiative includes a joint standard in development, demonstration projects in multiple cities in each country, technical road mapping, as well as projects to provide the public with more information.

5) 21st Century Coal Program (CERC-ACTV) promotes a cleaner use of coal resources, such as large-scale carbon capture and storage projects. The program calls for collaboration between a number of companies in the United States, including General Electric, AES, and Peabody Energy, which will be working with a number of Chinese companies to develop an integrated gasification combined cycle power plants, methane capture, as well as a number of other technologies.

6) China Greentech Initiative was founded in 2008 and has rapidly grown to become the only China-international collaboration platform of 100+ organizations, focused on identifying, developing and promoting green technology solutions in China. CGTI released its first free public deliverable, The China Greentech Report at the World Economic Forum in Dalian, China in 2009. With over 50,000 copies in use, the report is commonly referred to as the ‘primer’ by which to understand China’s greentech markets.

7) United States Alliances in Chinese Cleantech Industry includes the availability of a number of United States cleantech companies to invest into the Chinese cleantech industry. Currently, many companies from the United States are finding opportunities through alliances and cleantech and capital technology transfer investments. This leads to an increase in opportunities to assist cleantech into becoming one of the largest industries on a global platform. There has been much in the way of cross-border collaboration in many cleantech sectors, including solar and wind generation, water technologies, smart grid infrastructures, and electric transportation.

8 ) United States – China Renewable Energy Partnership develops roadmaps for widespread and continual renewable energy research, development and deployment in the United States and China, including renewable energy road mapping, regional deployment solutions, grid modernization, advanced renewable energy technology research and development collaboration in advanced biofuels, wind, and solar technologies, and public-private engagement to promote renewable energy and expand bilateral trade and investment via a new United States – China Renewable Energy Forum held annually. In connection with the U.S.-China Renewable Energy Partnership, another important area of U.S.-China cooperation is the Shale Gas Initiative.

9) United States – China Energy Cooperation Program describes itself as the only non-governmental organization that focuses on the United States – China business development within the clean energy sector. The partnership’s purpose is to “promote commercially viable project development work in clean energy and energy efficiency, and support the sustainable development of the energy sectors in both countries.” It was founded in Beijing in 2009, initiative by the United States commercial sector, and provides a vehicle allowing companies from both countries to work together and pursue clean sector market opportunities, address any trade impediments, and increase sustainable development.

10) Key U.S.-China Regional Cooperation Initiatives. An important layer of ‘connectivity’ in the U.S.-China clean energy business landscape is provided by long-standing, regionally-based cooperative initiatives. Top among these are the U.S.-China Green Energy Council (based in the Bay Area), the U.S.-China Clean Energy Forum (based in Greater Seattle with a Washington DC presence), and the Joint U.S.-China Cooperation on Clean Energy (based in Beijing, Shanghai and Washington DC).

Article by Shawn Lesser & Terry Cooke.

Shawn is president and founder of Atlanta-based Sustainable World Capital, which is focused on fund-raising for private equity cleantech/sustainable funds, as well as private cleantech companies and M&A. He is also a co- founder of the Global Cleantech Cluster Association (GCCA), and can be reached at shawn.lesser@sworldcap.com

Terry Cooke is Strategic Advisor for Global Partnerships for the Global Cleantech Cluster Association (GCCA).  He is also a 2010 Public Policy Scholar on U.S.-China Clean Energy at the Woodrow Wilson Center and author of the forthcoming Sustaining U.S.-China Clean Energy Cooperation being published by the Kissinger Institute of the Wooldrow Wilson Center.   His website is www.terrycooke.com .


There’s a curious disconnect in discussions about China’s ability to innovate. Yes, there’s no question that China lacks the chemistry to produce tomorrow’s Google — rigid educational system, lack of intellectual property rights protection, constricted flow of ideas, top-down control of ‘right thinking,’ etc. But what tends to get overlooked in this discussion is China’s headlong embrace of the future, the attitudinal openness to change. It perhaps took the searing experience of the Cultural Revolution to burn into the consciousness of present-day China where never to return and thereby to point the way to where to head — a modern and global future. We should be able to respect China’s focus on the future and, in doing so, avoid getting too comfortable in our present.

This article by James Allworth at at the Forum for Growth and Innovation at Harvard Business School puts this issue into clear perspective.

How the U.S. Could Avoid Being Disrupted by China by James Allworth, Harvard Business Review, 1:12 PM Tuesday December 21, 2010,

Last week, President Obama met with the CEOs of 20 of the largest corporations in the U.S. It was a widely praised meeting. But given what the President is hoping to achieve — creating sustained economic growth, which in turn leads to jobs — listening to much of what these guys have to say is the wrong approach. And asking them to start hiring misses the point. Obama is talking to the wrong people.
The U.S.’s position as a global economic leader has been based on one thing more than anything else: its ability to innovate. From Detroit to Silicon Valley, America has always been at the center of the “next big thing”. Each of the industries that have sprung up around these innovations has become an engine for America’s economic growth. Amazingly, each time as one has begun to slow down, the next one has picked up.
But this cycle is being jeopardized… [and in danger of] falling into the trap that leads to disruption — the same one that snares executives in many successful companies. Just as talented corporate leaders gradually shift their focus further and further upmarket in service of their best customers, the U.S.’s political leadership is increasingly doing that, too, by catering to the largest American companies… These are companies at their zenith. They have been through periods of exponential growth, but now they’re mature. America’s economic future is not dependent on the companies that are peaking now; the future is going to depend on the companies and industries that will peak in ten or 20 years time from now, the companies that are about to go through a period of break-out growth.
Unlike the startups that represent America’s future, the big players have an inherent bias toward protecting the status quo. They play a defensive game and face a different set of issues to their smaller brethren; fixing these issues is their priority when talking to politicians. The problem with this is that America’s economic competitiveness has always been built upon its ability to disrupt what it already has with something better. That’s a game played by smaller — not larger — companies.
Tilting the power balance in favor of large companies changes America’s winning formula. Here are just a few examples of where the big players and their undue influence in the political process have hurt America’s competitiveness, particularly relative to the U.S.’s emerging economic competitor, China:

• Big oil and big coal have stymied the growth of green energy within the U.S. Their lobbying and advertising have made it practically impossible to form political consensus. Putting aside the debate about the science, if the rest of the world believes global warming is real and is committed to stopping it, they’re going to want to get clean energy from somewhere. Right now, that’s not going to be the U.S. — it’s going to be China. What should be even more concerning to the U.S. is that while it remains too early to call, the green revolution looks like it’s going to be “the next big thing”, and the U.S. is set to miss out.

• The builders of every technical revolution — engineers — are being turned out at incredible rate in China. Compare the Chinese government’s attitude to that of the U.S. government. American politicians (at the behest of big content businesses) have tied federal funding of universities to anti-piracy efforts on campus. Do you think it makes sense to tie a country’s ability to innovate to protecting a business model that’s in the process of being disrupted?

• Intellectual property protections — frequently cited by big companies as being critical to innovation — are lacking in China. Ironically, this lack of IP is making China a more innovation-rich environment. The reason? The only protection you get in China is being able to innovate at such a rate that nobody else can catch you. Compare this to the U.S., where you create your IP and then rely on the legal system to keep your competitors at bay. This approach doesn’t work if your competitor doesn’t respect your IP laws. Further compounding the issue for America is that its current system strongly favors the big players. If a startup becomes a threat to a large company, then a common tactic is to rely on a long, drawn-out IP infringement lawsuit. Most startups don’t have the resources to fight back.

Over the past 20 years, America has gotten away with this shift in attitude, simply because it has had no competition. China changes that. The Chinese are determined to become a global hub for innovation, so America will have to compete to be the best environment in which to create the “next big thing” If the U.S. doesn’t want to lose its position and threaten its future prosperity, it’s going to need go back to its roots. The starting point is getting our political leaders to stop talking to the CEOs of large corporations and talk to entrepreneurs instead.

James Allworth is a Fellow at the Forum for Growth and Innovation at Harvard Business School.
Find the complete article at http://blogs.hbr.org/cs/2010/12/how_the_us_could_avoid_being_d.html

I wrote around to some contacts yesterday including a link to this article by Thomas M. Hout and Pankaj Ghemawat in the current issue of Harvard Business Review. 

China vs the World: Whose Technology Is It? – Harvard Business Review

Emon Wang, a partner at Spirea Capital, wrote back with some insight of his own:

“Interesting and impressive… maybe the best English article on this topic I read this year.

However, as a native Chinese who works in cross-border deals in cleantech from Europe I`d like to add some words:

– The relationship between Beijing and local governments are very complicated and subtle. For foreign players, knowing how to play with both side is critical. Tip for beginners: it`s practical to make friend first with local governments.

– Instead of complaining, in order to maintain competitive power, foreigners might spend more time and money on R&D at home, to ensure a leading position and be one step head of China and other emerging powers. Without continuous innovation, being caught up on is only a matter of time. VW shared its technology with China for so many years and is still the No.1 seller in the country, a hell of money they have made and I don`t think they lose any of their core technology strength. IMHO, if your stuff can be easily copied, then it makes theoretically no sense to over-protect it and increase the cost of simple technology artificially.

– What China lacks is exactly the ground of technology innovation and R&D competence. Not the available technology itself. Consider the growing number of high-educated Chinese both domestically and oversea, the next generation needs the infrastructure. The government is now building this up.

– Technology in exchange for market is a fair trade. No one is forced to share his technology (take Google for example, you can quit if you want). On the micro level it`s about greed. On the political level it`s about p/l and jobs at these multinational corporations. And it`s about negotiation. If you did your homework badly and made too many enemies, you can`t expect a good deal.

– All in all, if you really understand the Chinese history, you will understand why own technology competence is so important in the culture. It`s not about taking profit from the foreign corporation or about a technology war whatsoever.”

Tim Giesecke, author of the forthcoming EcoCommerce 101, made the following comment and asked for some clarification from me on Emon’s last paragraph.

Tim’s comment:  “Perhaps the timeline is the most telling – China becomes the #1 economy in 500 AD – looses the title in 1850AD – poised to regain it soon. We Americans will need to recognize asap that we can sit and be entertained, but not all the time.”

Tim’s question:  “If you can help me tie the ends of the last paragraph – technology competence is so important in the culture…is it to prevent themselves of becoming vulnerable to market forces, negoiations?”

My attempt at clarification:  “There’s a tactical level that has to do with negotiations (Sun Tzu’s Art of War and all that) but it is mostly a culturally-patterned value deeply embedded in Chinese (read ’embedded in the Han majority’ comprising 95% of the Chinese population) as a result of centuries of real and perceived humiliation on the global stage after centuries of preeminence. They don’t want to ever go back to that historical place of weakness and technology is their ladder out.”

Economists like to tell some jokes about trying to discern the
future – It is very difficult to forecast, especially about the
future. He who lives by the crystal ball soon learns to eat ground
glass. Jokes aside, the current business landscape is increasingly
complex and rapidly changing. A serious look at the future is essential.

First, before you look at future trends, you should enhance your trend watching skills. Thanks to TrendWatching (a great site –visit it for a further description of these tips, sign up for their newsletter) here are some tips –

  • Know why you are tracking trends
  • Make sure you acquire a point of view about the world around you.
    The more trends you spot and track, and the more skilled you are at
    putting these trends into context, the more guidance you’ll have.

  • Celebrate the incredible wealth of trend resources at your fingertips, many of them free or dirt cheap! (Yes indeed, more on this below)
  • Have a Trend Framework: basically a long list of all the trends we’ve spotted over the years.
  • Every company should have its own Trend Group. Even if that “group”
    is just you. The Trend Group is not some multimillion dollar/euro/pound
    affair. It doesn’t have to employ a dozen staff (though that would be
    nice ;-). It’s more a state of mind. It can be low-cost, unauthorized
    and grass roots if need be. Don’t wait for permission, make the Trend
    Group a fait accompli.

Ok, now let’s look at some trends. The first list is from Ernst & Young’s 2009 Global Megatrends

For a comprehensive discussion of these trends visit E&Y’s
website. This is one of the best resources on future business trends.

Asia’s Economy:                                               

Challenge and Opportunity for the Obama Administration

by Terry Cooke (www,terrycooke.com)

February 2009

Terry Cooke is a Senior Fellow at FPRI and the principal director of GC3 Strategy, Inc., an international consultancy specializing in sustainability-related technologies and capital linkages between Asia and the U.S. Previously, Dr. Cooke was Director of Asian Partnership Development for the Geneva-based  World Economic Forum. He has advised the Lauder Institute on global business outreach as a member of the University of Pennsylvania’s Wharton School’s Department of Management.  Dr. Cooke was a career-member of the U.S. Senior Foreign Service, with postings in Taipei, Berlin, Tokyo and Shanghai. This Enote is one in a series concerning Asia policy for the new administration.

The Obama administration faces a changed world. As a precarious economy and a global economic crisis have risen to the top of the U.S. security threat list, Asia’s geopolitical significance is looming larger. In adapting economic policy towards Asia under these conditions, the new administration must also confront the loss of U.S. reputation and influence that the financial crisis has entailed. It must communicate the causes and consequences of the crisis to the public and address them in policy. It has to take responsibility for U.S. policy failures while maintaining firmness where required of our Asian partners and reaffirming the basis of our enduring engagement with the region.

For the first time since Asia’s modernization, both the West and Asia are together falling headlong towards economic stagnation and deflation. More than a half-century of interdependent growth is now over, as the U.S. and Asia find their economies roped together and sliding precipitously downward.

The current crisis has its origin in a quarter-century of global trade growth which, particularly across the Pacific, has far outstripped global output growth. With the World Bank anticipating a drop of 2.1 percent in world trade in 2009 following this unprecedented 27-year boom, the rapid expansion of international trade has given rise to imbalances that are now threatening the global system.

Early Signs

The earliest signs of the current financial crisis appeared in late 2007 in the U.S. subprime credit markets. At the outset, observers tended to see this problem as an American problem. Asia was reassured by the thought that its economies, following decades of strong regional growth, had effectively “decoupled” from Western markets. While Asian markets were, with the exception of Japan, smaller in absolute size than counterpart economies in the West, they had been enjoying steady and high growth rates and seemed to be developing strong intraregional demand. The region, so the thinking went, would be inoculated against any economic flu afflicting the West. This hope was bolstered by Asia’s experience coming through the 1997-98 Asian Financial Crisis.

But throughout 2008, it became increasingly clear that Asia would not be a safe haven in the spreading crisis. Some of Asia’s highly touted emerging economies now verge on being “submerged.” While a drop of projected output from high single-digits to low single-digits might seem good news compared with the negative growth projected for the U.S. and other advanced economies, the ability of Asian countries to withstand the social and political effects of slower growth is open to question. Taiwan’s exports were down 44 percent in January from the prior year. Korea is currently experiencing a bigger collapse in exports and a higher rate of capital flight than it did as the epicenter of the Asian Financial Crisis. The government of China has already announced that an estimated 20 million manufacturing jobs have been lost, with many more expected by late spring.

What Happened?

The root cause of instability has been an imbalance long embedded in the global trading system between a debt-leveraged structure of consumption in the Western economies and a savings-biased structure of export dependence among Asian economies. In recent years, this imbalance has reached unsustainable levels as a result of China’s quantum expansion of the vaunted Asian growth model.

After decades of unprecedented global peacetime growth, China’s quantum-level expansion of Asia’s traditional, export-led manufacturing model combined with other factors such as new demands on global supply from the rapidly growing middle-classes of China and India have tended to accentuate existing imbalances in the global system. In the resources realm, this disequilibrium took the shape of price spikes and commodity shortages for energy, food, minerals and other natural resources over recent years. From second quarter 2007 to second quarter 2008, the NYMEX price of oil doubled. In tandem, global food production, highly dependent on energy-intensive fertilization and dwindling agrable land, rose in price beyond the range of poor consumers. Political discussions of energy and food security took on new urgency, as did debate over how to combat climate change. In the area of global finance, rapid growth further amplified the basic disequilibrium between consumption-led growth in the West and export dependence among Asian economies. In China, the level of foreign exchange reserves resulting from its successful expansion of the export-led growth model rapidly eclipsed the level of surplus generated by Japan and Taiwan in earlier decades. Simultaneously, an upstart group of new sovereign wealth funds (SWFs) popped up to recycle the bonanza of petrodollars in the Middle East as well as foreign exchange surpluses in Asia resulting from booming exports to the West. China’s sovereign wealth vehicles, China Investment Corporation (CIC) and State Administration of Foreign Exchange (SAFE), began acting as new drivers of Beijing’s effort to draw in raw materials from around the world. In parallel to Beijing’s resource-attuned policies in Africa and other parts of the undeveloped world, China’s SWFs vetted acquisition of global resource companies in Australia and elsewhere in the developed and developing world. In the wake of the collapse of CNOOC’s bid for Unocal in 2005, Chinese SWFs were scrutinized with regard to the motivation for, and transparency of, their activities. In Washington, Congress increasingly preempted the executive branch’s public lead on these issues, fanning exaggerated fears in China of a supposed U.S. determination to block China’s rise.

Meanwhile, U.S. consumers kept piling on more debt to continue their splurge in the housing market and to absorb the flood of low-cost goods being churned out by Asian factories. To keep their export levels and employment in their factories high, China kept financing U.S. over-consumption through the recycling of its foreign exchange surpluses into purchases of U.S. Treasuries and other stable debt instruments.

While openly caustic about the United States’ biting the hand that feeds, Beijing has few other options for recycling its surpluses. Given the scale of the reserves being recycled, no other form of investment offers close to the capacity, liquidity, and relative safety of dollar-denominated Treasury issues. While there is ample blame to share on both sides, then Undersecretary of the Treasury Tim Adams put it best when he said in 2006, “You can’t have a situation where everyone complains about U.S. consumption and then drives their economic strategy to survive off that consumption.”

Under the Bush administration, China policy was mostly run through the Treasury Department and Hank Paulson’s Strategic Economic Dialogue (SED) process. For the U.S. side, the fulcrum of these negotiations was to wean Beijing away from a policy of fixing artificially low exchange rate for the yuan as a means to boost to China’s export industries. Since the first, grudging signs of China’s responsiveness to this negotiating push, the yuan did appreciate 21.5 percent against the dollar over the three-year period from mid-2005 to mid-2008. This level of appreciation was a step forward but is modest given the overall degree of bilateral and global structural imbalance. 

However, since the onset of the financial crisis, that movement has stalled. During the fifth, most recent SED meeting in Beijing in December 2008, the chair of the Chinese side, Wang Qishan , lectured the U.S. delegation on U.S. consumer profligacy. At the Davos World Economic Forum meeting in January 2009, Premier Wen Jia-bao broadened this critique, in unison with Russian Prime Minister Vladimir Putin, to a more general attack on the Western financial system. Despite these rhetorical flourishes and the stated fears from many quarters that the crisis might prompt China to reverse direction and devalue its currency, the yuan has held steady in recent months. In effect, Beijing is choosing to practice the Taoist art of wu wei (“do nothing”)  with its exchange rate policy while weathering the first bouts of financial turbulence and reckoning the direction of the new Obama administration.

In forming its economic policy, the Obama administration must find a means of breaking the sterile cycle of recrimination engendered by a narrow focus on exchange rate policy. Leading the world economy will require the U.S. to curb its own excesses and to offer a more compelling vision to encourage trade partners in Asia to move forward together as stakeholders in the global system. A renewed commitment to world trade can be a starting point.   (continued in next entry)


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