Silicon Hutong

China's Auto Reform: One Foot on the Gas, One Foot On the Brake

In the Hutong

Good grief, March already?

2111 hrs.

The Associated Press is reporting that we can expect China to undertake a reform of its largely state-owned auto manufacturing sector. The plan apparently calls for China to winnow the number of domestic auto manufacturers from 14 down to 10.

No, Not THAT Big 10...

The AP report refers to a Chinese "Big 10" made up of a top tier of auto makers with the capacity to make 2 million vehicles or more (Shanghai Automotive Industry Corporation (SAIC), First Automobile Works (FAW), Dongfeng Motor, and Changan Motor) and a second tier of six manufacturers with capacity of around 1 million cars per year.

First, some perspective: a million cars a year is not small, but Ford and GM will probably make around 9 million vehicles apiece this year, so "Big 10" is still relative.

Second, in an environment where the auto business is so difficult that even Toyota is starting to sweat, one might ask whether China is being a tad cautious in reforming the auto business. It would seem a tad ambitious to envision a global market with sufficient room for ten Chinese car brands.

In truth, China is being cautious about consolidating the country's auto business, and for good reasons.

Slow and Steady

The first and most important is the geographic dispersion of China's car makers, and the political challenges that implies. Unlike the U.S. car industry, which was traditionally concentrated in the state of Michigan, China's automakers are scattered around China.

Closing one - even if it is just eliminating the brand and keeping the factory - means favoring one region over another, and that is sensitive in an economy so careful with its local companies that domestic protectionism remains a major challenge to the country's development.

Edmunds Inside Line notes that if local governments want they can derail the process. Even if they do, that derailment won't be permanent - the central government will get its way, but the question will be the cost: each closure is going to demand negotiation and horse-trading among the governments, meaning more costs and delays.

Second, China does not want to undertake consolidation at the expense of market share. Foreign makes still take up over 60% of local vehicle sales by volume, and closing down too many local companies too fast will mean that foreign marks will gain ground. Given China's stated intention to create global auto marques of its own (rather than just being the factory for European, Japanese, Korean, and American brands.) Given that the ability of the remaining 10 automakers to increase capacity is limited, best to go slow.

Third, all of the industrial policy in the world does not make up for solid market performance. It is still too early to tell which automakers will be able to make the difficult shift into international markets and then be able to build that into global leadership. Picking candidates, not winners, is the wise approach now.

Upshift

Finally, there are the intertwined issues of technology and the environment. And for us here in the Hutong, this is a big one.

In the coming decade, China's auto industry is going to have to shift away from petroleum-fired internal combustion engines to something else: The country's air quality will not be able to take hundreds of millions of cars running on unleaded; simply fueling those cars would put China into a geopolitical face-off with the U.S. and Europe; and the global car manufacturers who remain after the global downturn will be producing their own low-emission or zero-emission vehicles in China.

That shift is going to mean investments so large in technologies so complex that it may force a rethinking of the entire automobile industry. The logic of a single vertically-integrated manufacturer starting with steel, plastic, and rubber and churning out cars may not hold is the industry makes its leap.

As such some companies in China's auto industry may well elect to specialize either in assembly or components, opening the door for one or more of the current players to ease their way out of making cars and into supplying China's remaining brands with motors, batteries, fuel cells, bodies, or other major components.

If that happens - and I suspect that at least in the case of second-tier brands it might - it makes more sense to allow that specialization to evolve and chivvying it with the visible hand of government, rather than making those choices now. The coming years, in fact, are likely to involve the government making the case to some manufacturers move to making parts and components.

Taking a "slow-cull" approach to reforming the industry is the wise approach for China's policy makers. The nation's auto industry will be reformed in stages rather than with the single stroke of a pen, and the speed of those reforms will depend not only on market growth and global finance, but on the demonstrated ability of China's automakers to withstand the successive waves of change they will face in the coming years.

Why Land Reform is a Tech Opportunity

In the Hutong

There's something about a high-fiber snack...

16:23 hrs.

In the flurry of news about plans to reform land use in China, much of the coverages focuses on the new potential for Chinese farmers to either pay to farm the land of others, or to indeed expand their own plots by renting more land, thus building scale and offering the greater potential for profit. I think a lot of people noted this, and after checking to ensure that neither Monsanto, John Deere, nor DuPont was in their stock portfolio, dutifully forgot it.

There is, however, more to this story.

Not Your Father's Land Reform

While the idea of land reform gets folks in the agriculture business dreaming about China's vast farmlands changing from a patchwork of tiny plots to a more orderly quilt of massive farms, that dream is both unlikely and overrated. The omnivorous Tom Barnett notes an important point Callum MacLeod makes in his article in USA Today:

"China is the opposite of the USA, which has an abundance of capital and land. In China, labor is abundant, but it is short of land and rural capital, [said Li PIng, of the Seattle-based Rural Development Institute.]

In short, don't count on Hebei starting to look like the upper San Joaquin Valley anytime soon.

But let's take a closer look at Li's point.

• China has abundant labor. Yes, and that is not likely to go away soon, massive urbanization notwithstanding. America has under 6 million people living and working on farms. China has around 700 million. You could literally cut China's farm population by 90% and still have too many farmers to replicate the efficiencies of U.S. farms.

• China is short of land. Yes, and that is not likely to change anytime soon, either, unless China plans to invade and cultivate the Siberian steppes. Whether taken as a ratio of land under cultivation to the total national land mass, or as a ration of arable land to population, Chinese agriculture is land-deficient.

• China is short of rural capital. Yes, it is now. This, however, unlike the previous two conditions, can change. And therein lies the real opportunity behind China's land reform.

AgriBusiness with Chinese Characteristics

Regardless of how much you change China's agricultural land use rights, you're always going to have too many people cultivating too little land, which means that the future of Chinese agriculture is not about vast wheat fields or free-range beef ranching. You have to find another model.

At the most basic level, this means that China's farms will find prosperity with crops that demand a great deal of human attention, and that will capture market prices that will allow farmers to compensate their workers accordingly. But more labor working fewer valuable plants is only half of the answer. There is a shortage of water available to farmers in a growing proportion of the country. Air pollution, soil degraded by poor irrigation practices, and lousy infrastructure still hamper the industry.

At the same time, consumer demand for higher value farm products means that for most farmers their real opportunities lie with crops they are not accustomed to cultivating. With some exceptions, China's successful farmer of the future will be a small- or medium-sized agribusiness focusing on high-value cash crops or horticulture (flowers and foliage.)

So when Li Ping talks about rural capital, we need to think beyond cash: China's farmers also need equipment to address environmental and infrastructure challenges, as well as the know-how to get the most out of whatever size plots of land they can cobble together under land reform. Which, in turn, means that land reform is the first step to liberating the value of Chinese farmland, rather than the last.

Chinese AgTech

I would love to say that technology is a panacea that will clear up all of these challenges, but if I did, I'd be wrong. Nonetheless, there is a growing range of opportunities for technology to help turn the more entrepreneurial of China's farmers into agribusinessmen. Just a few of these include:

* Drip irrigation: China's shortage of fresh water is already bad, and it is going to get worse. Chinese farms will only be sustainable if they use exactly as much water (and fertilizer, and nutrients) as they need, and no more. Drip irrigation is the best, most practical solution today. As aeroponic techniques develop beyond space travel and dorm-room cultivation of cannabis sattiva, they may eventually supplement drip irrigation, but likely only for specialized applications.

* Greenhouses and Nurseries: beyond the vagaries of pests and weather, the challenges of China's environment is likely to drive the production of cash crops - not just flowers - into greenhouses. We see a lot of this around major cities and in centers like Kunming, but expect this to expand. This involves more than just covered farmlands: it also means temperature monitors and controls, irrigation systems, air-quality management systems, and harvesting.

* mAgriculture: few Chinese farmers can afford laptops, but many more can afford mobile phones to monitor their crops, the weather, and market prices, as well as to take orders, capture opportunities to sell at higher prices, and make payments on supplies and micro-loans. Farmers will need inexpensive yet rugged and waterproof handsets with large buttons, long battery life, and possibly even solar charging capability. They will also need easy-to-use service bundles to include information access and mobile banking.

* Training: there is just no way to get millions of farmers into schools. Raising skill levels in new crops, new tools, and agricultural economics is going to involve a combination of traditional low-tech methods and some experimental efforts in using remote training via satellite TV and possibly the Internet.

* Finance: once you have the land, you need the cash to develop it and to finance your first crop. Traditional methods of agricultural banking in China, including banks and farm co-operatives, won't be enough. Micro-finance, in all of its forms, can be most economically administered using technology. That doesn't mean a computer on every farm, but it does mean loan officers in rural areas equipped with at least hand-helds to help manage payments and collections.

These only touch the surface, and there will be specific opportunities around specialized crops, but you get the point. As we slide gently into global recession, technology firms have an opportunity with Chinese land reform to begin developing - or at least researching - how to deliver products to help solve some of the challenges implicit in China's next green revolution.

The ARJ-21 and China's Long, Slow Climb to the Skies

In the Hutong

No place else I'd rather be

1158 hrs.

Covering this year's Zhuhai Air Show, The Economist takes a look at China's first domestically-produced jetliner, the AVIC1 Commercial Aircraft Corporation's ARJ-21, and on the eve of the regional jet's maiden test flight takes a moment to consider its commercial prospects. Their verdict: don't count China out.

Many foreign analysts doubt that Western airlines will ever be prepared to buy Chinese aircraft. But, as in other fields, China is playing a long game.

Much of the debate about the ARJ-21 thus far has centered around two issues: first, whether the ARJ-21 will attract buyers beyond the Chinese airlines who are compelled to purchase it (and GE, who is making a pile selling engines for the jet); and second, whether China will ever develop a globally competitive civil aviation industry.

Both questions miss the point. What is most important about the ARJ-21 is the lessons it teaches us about the process China goes through to catch up with the rest of the world in technical, complex, high-value industries.

Watch Process, not Product

If you look at all of the technical sectors in which China has built commercially viable businesses, you can discern a clear process by which the nation's industrial policy kick-starts these efforts. In the case of cars, computers, mobile phones, and now commercial jetliners, the pattern is dependably consistent. Let's call it the Four C Model.

First, comes what I call the "capability" phase. the government typically announces a national project to build its own version of an technical product. It turns to a government research institute or a similar organization, which in turn pulls together the team from across the nation's universities and enterprises. Eventually they manage to produce a one or more prototypes, but there is no real possibility of commercializing the product.

Upon review of the initial prototypes and the development process, typically a range of issues is identified that prevented the commercialization of the product. As a result, during the next "collaborate" phase, China sets up an enterprise to build the product using foreign designs, components, and know-how. The result is not quite commercially viable, and may only sell to local customers because of tariffs, tax-breaks, or other subsidies that make the local product appealing to local customers.

Next comes the "component" phase, when a local company creates its own design or modifies another, and many of the parts, but key, mission-critical components come from overseas. In this phase the product is adequate and by most measures comparable to foreign products, but with no track record only the most adventurous foreign customers are ready to trust the product.

Finally, all of the technical kinks are worked out, there are several Chinese companies involved in the effort, and with a demonstrable track record behind it, China is ready to go head-to-head with global companies. This is the "competitor" phase, and it usually marked by brisk sales and the beginnings of a true competitive advantage.

Not Quite a Competitor

In the case of the ARJ, China's effort to build its own jetliner has reached the "component" phase, and it has taken 35 years to get this far.

In the early 1970s, China began a project to prove to the world it was capable of making its own jetliner. the result was the now almost-forgotten Shanghai Y-10, which was as close to a clone of the Boeing 707 that the nation could produce in the late 1970s. Two prototypes were produced. They flew in the early 1980s. China made its point. And the jets never saw commercial service: they were essentially flying monuments to China's aspirations. This was the "capability" phase.

Not long after, China got involved in negotiations with McDonnell-Douglas Aircraft for a joint-venture to assemble their MD-80 class jets in Shanghai. The JV went through brutal political turbulence and costly delays, and in the end the venture sold only a fraction of the jets it had hoped. McDonnell-Douglas was sent packing, but China was left with an entire generation of aircraft engineers, a lot of very helpful tooling, and the groundwork to take the next step. Thus ended the "collaborate" phase.

After nearly a decade of thinking, planning, proposals, and counter-proposals, and even another shot at collaborating with other Asian aspirants, China launched the ARJ-21 (Asian Regional Jet - 21st Century) project. This is the "component" phase, and at this point China is serving as re-designer (the jet is basically a shortened MD-80, or DC-9, with a new wing design from Russia), project manager, and system integrator.

Tough Room

China's aviation policy-makers and industrialists knew the ARJ-21 would be playing in the most competitive end of the civil aviation pool. The regional jet field is dominated by Canada's Bombardier, with its CRJ series, and Brazil's EMBRAER, with its ERJ series, both of whom have complete lines of aircraft, global technical support, and who built their business on solid reputations for making dependable aircraft.

Three very old names in the aviation industry, British Aerospace, Dornier, and Fairchild, have already been driven out of the aircraft manufacturing business after losing out to Bombardier and EMBRAER, and Boeing's 717 was squeezed out of its market niche with a plane strikingly similar to the ARJ-21. Four other very old names in the aviation industry, Antonov, Tupolev, Sukhoi, and Mitsubishi are all getting ready to pounce on the ARJ-21's markets with brand new regional jets of their own.

So there is not much hope for the ARJ-21 beyond China. And prospects inside of China are not that great, either.

Fat Planes Wanted

The idea behind a regional jet is that you have flights under two hours duration connecting cities under 1,800 kilometers or 1,100 miles apart where you cannot economically fill, say, a Boeing 737, or where the field might be a little short for a small jetliner.

In China, however, the problem is that we have a limited number of airports, a limited amount of airspace, and a whole lot of people who want to fly. There will be some market for regional jets, but in the medium to long term China needs larger jets that make the best possible use of the limited resources in Chinese aviation (i.e., concrete and airspace) to move the maximum number of passengers at the lowest possible cost.

Finally, let's not forget that perhaps the most serious competitor to regional jets in China doesn't even fly. China is in the early phases of a madness for high-speed intercity rail transport. The threat posed by trains as fast as Japan's Shinkansen and France's TGV is most serious to the shorter air routes served by the ARJ. As the price of jet fuel goes up (and, despite current trends, it surely will), that threat grows all the more critical.

Back to our Model

There are other issues, such as a total cost of ownership for the ARJ-21s that are going to be higher than carriers are being let to expect. With all factors in consideration, the ARJ-21 faces some roaring headwinds.

But again, what is important is not the plane itself, but where China's jetliner manufacturing industry will be after the ARJ-21. And here is where it starts to get really interesting.

Just as the ARJ-21 goes into full production, Airbus will be completing its A320 assembly plant in Tianjin. Between the two, China will for the first time have two factories cranking out airliners. The benefits to the industry will be enormous. China will have created overnight a workforce of engineers, machinists, and all of the other specialties involved in aircraft assembly.

In short, by 2014, the groundwork will be in place for China to make the next jump, and the ARJ-21 team will have had five years learning what it takes to support an airliner in the field, sometimes even in the most challenging locations.

What is more, right about that time, Boeing and Airbus will be under pressure from their customers around the world to develop successors to their single-aisle jetliners in the 110-170 passenger range. Both have made it so far by updating and extending their 737 and A320 lines. Five years from now, that may not be enough.

At that point, the door will open for China to enter the fray with its own design, and they will have the benefit of being able to work with the world of suppliers and subcontractors - both in China and overseas - that Boeing and Airbus have helped create. And with Boeing and Airbus forced to contend with powerful unions determined to secure for their members a comfortable American or European middle-class lifestyle, China may well offer a nice cost advantage as well.

All things being equal, then, China may well be able to compete in the small airliner market by 2020.

A Lesson, not a Product

Again, though, this makes the ARJ-21 a stepping-stone, not the destination itself. As such, the success or failure of the ARJ-21 project cannot be measured solely on the basis of aircraft sold. Rather, it must be judged on its by-products, on the extent to which it prepares the nation's aerospace industry to take the next, all-important step and become a global competitor.

Funny, I thought it was a new kind of herb...

In the Hutong

One month to go

2039 hrs.

There are a lot of terms people use that they do not really understand, and I am as guilty of that as anyone out there. I didn't understand "soft power" until I read Joseph Nye's book. I had no clue about social networking until I actually started doing it.

And even though I deal very rarely with finance, there have been two occasions when I've used the phrase "Basel II requirements" in a conversation about Chinese banking when I realized I only understood a single specific piece (the minimum capital requirement) of the global standards by which banks are increasingly judged. I kept smiling, but I broke into a cold sweat.

You know that feeling, right? That feeling like you are walking happily across a frozen lake, and then you wake from your reverie to realize that you are on thin ice, that you have walked the conversation right up to - and sometimes beyond - your real level of knowledge. And you are about to be exposed for the pretentious idiot that you are for having had the conversation in the first place.

Okay, well, maybe you don't. But I've felt it, and I hate it. Once my internal baloney alarm kicks in, there are only two solutions: never, ever, go there again; or set about learning more.

So I went hunting, and I found this juicy little pdf at the Bank for International Settlements website - the full text of Basel II: International Convergence of Capital Measurement and Capital Standards Revised Framework - Comprehensive Version. At 347 pages of dry text, it was probably more than I needed, but being the finance tyro that I am I kind of get a kick out of reading it. I feel like I'm a fly on the wall at a meeting of central bankers. The wikipedia entry was a little too light on detail anyway.

Olympics: Whither the Great Venues?

In the Hutong

Productivity = no TV in office

1917 hrs

We are still over a month away from the opening ceremonies, and I am already hearing of reporters filing stories on the "Olympic Legacy." Yeah, I know, it seems a bit early for that kind of speculation, but especially for those of us who will remain behind when all of the athletes, officials, and visitors have left, it is a matter of real concern.

From the point of view of the people here in the Hutong, the infrastructure improvements alone are worth the hassle of the games coming to town. We are being left with: a beautiful (huge) new airport terminal with an extra runway on the side; the beginnings of a rapid transit system worthy of the name; a whole lot of new buildings; wider streets; and vast belts of green where once was concrete.

Quiet Giants

Oh, yes - we're also getting some brand new sports venues, and all the rest are getting facelifts.

It does not take a futurist to know what will happen to these magnificent venues after the Paralympics closes in September. Some, like the beach volleyball arena, will come down instantly. Others will see their seating removed. A few - most notably Arup's iconic National Aquatics Center, or The Water Cube (that's [H20]^3 for my fellow geeks) have been designed with a post-Games life in mind.

But many, I'm afraid, will stand silent for much of every year.

There are two issues, separate but somewhat related.

Promoters must Promote

First is the dismal state of the live events business here in China. I do not put myself out as an expert in this field, but I've been working along the edges of the business for long enough to know that the problem here is neither the number of people who would attend a concert, nor the cost of a ticket, nor of a lack of bands, symphonies, stage plays, artists and the like who would be willing to come to Beijing.

The problem is with the promotions side of the business. Live event promotion is for all intents and purposes a state monopoly. With all due respect to the hard-working people in that monopoly, it is too often fair to say that events are poorly promoted, badly managed, and sometimes not fun at all. And that's just from the consumer point of view. I can only imagine how it must drive sponsors and tour managers nuts to deal with promotors who do not appear to be interested in helping to put on a killer event.

Just to take promotions: I read the weekly entertainment giveaways as closely as the next guy, and I find myself learning about events, plays, concerts, and the like either the day of or a week after the fact so regularly that it is infuriating. I can more readily find out about who is playing the Greek Theatre in Los Angeles next season than I can find out about a concert in Beijing a month from now. Frankly, unless I see an ad two weeks in advance in The Beijinger or I'm regularly checking the Emma website, I may never find out.

Unfortunately, I doubt major improvement - a stage where tour organizers and event sponsors are all talking about how easy and enjoyable it is to take a show through China - is in the offing anytime soon. That would require genuine competition in the live events promotion space, maybe opening it up to other state-owned media organizations like China International Television Corporation, Shanghai Media Group, China Radio International, or even the Phoenix Satellite folks. That is just not in the cards right now.

We need a new ball game

The second issue is the state of professional sports in China. There is more to creating a successful (dare I say "world-class") sports league that slapping some spiffy kit on a bunch of healthy young males.

If you want an idea of how far professional sports have progressed in China, take a look at professional soccer. There is a league. It has its hard-core of followers. But it is by no means the popular sensation here that it is even in Japan, much less anywhere in Europe.

I once had a long, drink-sodden discussion in a karaoke bar with one of China's senior soccer coaches. He blamed China's lack of soccer prowess on a whole range of issues: lack of endurance, lack of speed, inadequate diets as children, whatever. And he may have been right.

When you look around the world at some of the leading sports leagues, though, you start to see a pattern emerge. When a country is a global leader in a given sport - any sport - it is because of a system.

Take English soccer. Sure, there are plenty of foreign players in the Premier League. But English soccer got where it was because of the Football Association. With clubs in nearly every city, suburb, village, and hamlet across England, all ranked in over a dozen tiered leagues based on performance, you have a system designed to screen, identify, and develop talent from the largest possible pool over the longest possible time.

Take American baseball. The kids start with t-ball, then move on to little league, then high school, then college. At each level, only the best stay with it as they grow. Then there are seven levels of professional minor-leagues as development programs for the major leagues - last time I counted, there were over 329 teams in five countries all developing professional baseball players for the 30 major league teams.

American basketball and football rely much more heavily on high schools and universities to develop players, but given that these two sports are arguably the most successful and lucrative sports at the collegiate level, they do a fine job screening, recruiting, training, and preparing athletes. (I'm not in favor of this approach, personally. The Village Grouch and I both advocate either a minor-league system like baseball or an association system like English soccer. But that's not happening anytime soon.)

Japanese baseball, Canadian hockey, and Australian rugby all follow similar systems.

The formula for developing exciting professional team sports, therefore, is simple: create a system that by enabling broad participation at the earliest practical age ends up casting the widest possible net talent, opening the door for each player to get the the best opportunity for development, and you wind up with a huge pool of talented team players rather than a few stars surrounded by second- and third-rate players who are just no fun to watch.

China needs to find a way to duplicate the essence of systems like those of the Football Association and Major League Baseball in a way that is locally appropriate. Of course, the scale of such an undertaking means that it will take at least a generation to produce professional sports of a high caliber. But now is as good a time as any to start.

Wanted: motivated bureaucrats

If any of the above is to change, it will require some severe motivation from someplace very high in the government. More than just about creating sports leagues, holding concerts, or filling expensive venues, this is about creating industries of entertainment, ways to identify, nurture, showcase, and reward talented Chinese people as well as bring them the greatest talent from around the world.

If the hearts of the nation's policymakers are not stirred into passionate pursuit of robust live entertainment and sports industries by the prospect of the economic development and opportunities they would bring, perhaps the sight of these giant venues - national treasures - sitting empty and quiet will do the trick.

I think it will happen. China's leaders detest waste and love an opportunity.

Now if someone would just make the suggestion.

Cross-post: Taking the high (rail) road

ARTICLE: "Last Stop: Lhasa: Rail Link Ties Remote T1bet to China," by Joseph Kahn, The New York Times, July 2, 2006

BOOK: Nothing Like It In The World: The Men Who Built the Transcontinental Railroad 1863-1869 by Stephen E. Ambrose, New York, Simon & Schuster, August 29, 2000.

BOOK: Empire Express: Building the First Transcontinental Railroad by David Haward Bain, New York, Viking, November 1, 1999

With no other intention than pure escapism, about six weeks ago I finally pulled off of my shelves two unread books about the building of the first transcontinental railroad across the United States. I've finished Stephen Ambrose's highly readable work, and I'm now deep into David Haward Bain's well-written, far more scholarly tome on the subject. In retrospect, the timing could not have been better, as global coverage begins on the opening of the final 712 mile section of the Beijing-Lhasa railroad.

The parallels are compelling:

• The Pacific Railroad (as the transcontinental railway was called in the 1860s) was a dream almost as old as the American Republic, having been a matter of discussion for nearly 50 years before it was realized. Similarly, the Lhasa railway has been on and off of the national agenda in China for over 50 years.

• The political reasons given to justify the expenditure in both cases was "to tie the nation together" by linking a remote region with the rest of the country.

• The Pacific Railroad could never have been completed without Chinese help (in particular, the effort to get through the Sierra Nevada mountains of California.) Similarly, the Lhasa railway relied on western help to address some critical challenges.

I could go on, but you get the point.

More important, perhaps, is contrasting foreign coverage of the Lhasa link with the coverage given the Pacific Railway some 140 years ago.

Perhaps in the age of air travel we've all grown a bit bored by railroads, but I think that's because in an age of air travel and truck transport, railroads seem a bit quaint. In regions like North America and Europe, with their wealthy economies and dense populations, freeways, autobahns, and discount airlines railroads seem relegated to hauling coal or commuters. (They aren't, but that's the subject of another post.)

What we lack, therefore, is an appreciation of two things: how hard this was to do, and what effect this will have on Xizang.

A Engineering Feat and a Human Achievement

Ambrose and Bain both make visceral the science, craft, and sheer physical effort it takes to build a railroad across a mountain range. You need to find an "alignment," a course for the road that does not rise more than about 100 feet every mile, but that is as straight as possible because every foot of railroad in terrain like this costs a small fortune.

You then need to dig, chip, and blast the grade through cuts and tunnels through mountains of solid granite. You need to fill or bridge rivers, canyons, gulches, and even little dips and do it in a way that won't be washed out by floods, avalanches, or made impassible by high mountain winds.

And if you think that's easy in the 21st century, remember that you need to do all of this in some of the most remote territory on earth, hauling men, machines, material, and the food, energy, and fuel to keep all of them working up a narrow artery of steel.

Oh, yeah, and one other thing. You've got to do all of this at an altitude considered too uncomfortable or indeed unhealthy for a sleeping airline passenger, much less a manual laborer.

But with few exceptions (notably Rui Xia's superb late-2005 Asia Times article) you'll see very little credit given to China's engineers and workers for accomplishing this task in the international media. That's a shame, not only because these hardy souls deserve it, but because the failure to give such credit causes the Chinese and foreign engineers who know how tough it was to build the Lhasa road causes all of them to question the balance of the international media on Chinese topics. In addition, it allows observers to underestimate the innate capabilities of Chinese engineering in spite of the kind of big-ticket-project related shenanigans we're used to hearing about in China.

The Great Wall Builders are back. All of us should be contemplating the implications.

Linking Lhasa

Joseph Kahn has put forth a yeoman's effort covering the story from his chair in Beijing, as much as I'm sure he'd have rather been covering it from the train itself. It's left him taking a more political take on the road, which is a shame. I won't go into what he wrote - you should give him a read yourself.

Given the sheer volume of hyperbole from both proponents and opponents of the line, it is impossible to capture with any justice the essence of either position, much less debate it. But a few thoughts to contemplate as you weather the barrage of coverage.

Expecting a single rail line passing through a small part of a province larger (and less accessible) than Alaska to bring fundamental economic change to the region stretches the bounds of credulity. Certainly, those living it Lhasa and its environs will experience some quality of life improvements based solely on the fall in the cost to schlep goods up the hill. It also opens the region up to a class of tourist or traveler who cannot afford an air ticket.

For the line to deliver any significant economic benefit (or harm, depending on your point-of-view,) its Lhasa terminus must become the hub of a transportation and communications infrastructure that links all of the cities and villages of the region. That's the sort of nitty-gritty investment that is difficult to justify when sitting in Beijing, but that will become necessary if the nation is truly serious about including the Xizang province on the benefits of the China's economic development.

As to whether the road will Sinicize the local culture, that is a far trickier question that in the end is determined more by one's political and ideological viewpoints than on anthropology. There are some who see Xizang as the Shangri-la of James Hilton's novel Lost Horizon and thus see any intrusion of modernity as the functional equivalent of genocide. Fair enough.

Yet in no small part, the matter remains in the hands of the locals themsleves. It is instructive to note that in the face of globalization we live in a world where a wide range of distinct cultures and ethnicities have survived or even flourished.

For what destroys cultures is not the coming of railroads, but the departure of relevance. History demonstrates that a culture that is deeply relevant to those who treasure it will survive. As long as a culture remains meaningful, assimilation will be held at bay.

(None of this, of course, is likely to mollify someone (like that deep political thinker Richard Gere) who maintains a canonical belief in the value of turning the Xizang province into an isolated mountain theocracy. For those folks, I'd suggest that a review of the histories and status of Nepal and Bhutan serve as good examples of the direction such an experiment might take. They invite pondering.)

On to India

One last thought about the railroad. Throughout history, railroads have also served to pierce and bridge borders between nations. In my view, the High Road to Lhasa is half a road that will accomplish its greatest historic purpose when it can form the bridge between Delhi and Beijing.

Contemplate that.

Originally posted 2 July 2006

Figuring out sustainable development

In the Hutong

Waiting for the rain

1212 hrs.

The phrase "sustainable development" has become a buzzword, which means that a lot of people are talking about it without being quite sure what it means.

That is starting to change. The prestigious Commission on Growth and Development (chaired by Stanford's Michael Spence and including such luminaries as Governor Zhou Xiaochuan of the People's Bank of China, Singapore's Senior Minister Goh Chok Tong, former Mexican president Ernesto Zedillo, Citigroup chairman and former U.S. SecTreas Robert Rubin, and Nobel economics laureate Robert Solow,) last month released a report titled Strategies for Sustained Growth and Inclusive Development. 

It's fairly readable as these things go, but it points out very early on that there are no pat answers - only some lessons learned and a framework for asking the right questions. It is nice to see such a report deviate from the kind of preachy prescriptions we tend to hear from the IMF, World Bank, and other big international non-governmental organizations (BINGOs). 

Download the PDF here.

Cable TV in China: Invest Elsewhere

In the Hutong
Yes, dear, toast is dinner
1938 hrs.

Earlier this month, I was honored to sit on a panel on the future of China's cable television industry sponsored by the American Chamber of Commerce, joined by my friend Kris Kender from CMM Intelligence (the guys who publish the China Media Yearbook & Directory), Leo Austin of Augus Partners, and Tao Libao of China Multimedia Networks. The panel was expertly guided by Jeremy Goldkorn of Danwei.org.

139 Million What? I'd Like Some of That...

On the minds of many of the people in our audience was when and how it would be possible for foreign companies to make some money on the 139 million cable TV subscribers (that's households, not people) in China.

The hopes of the industry are pinned upon some valid commercial and economic truths:

- After nearly two decades of development, cable TV in China is little more than basic cable, a depressing collection of 40 or so look-alike channels with content that is occasionally superb but more commonly mediocre;

- Cable operators make a pittance - maybe RMB 14 per month per subscriber on average;

- Getting cable operators out of this low-end rut means adding more and better programs, new channels, more services, and putting in the systems that will allow operators to charge for them;

- The country (i.e., the nation's cable operators, taken collectively) has invested billions of dollars on fiber-optic and cable networks, and would clearly want to get the most economic value out of all of that wiring;

- Chinese people love home entertainment.

All of this would seem to spell endless opportunity for companies, both foreign and domestic, seeking to make fortunes selling networking equipment, head-ends, set-top boxes, software, expertise, and even programming to China's cable industry.

Funny, It Didn't LOOK Like a Mirage

There is only one problem:

Cable TV in China is not an industry.

At best, it is a highly regulated utility.

At worst, it is a technological laboratory for engineers.

Chinese law and policy state emphatically that foreigners cannot own or control cable TV stations or channels - that is reserved of Chinese organizations, and only those so authorized by the State Administration for Radio, Film, and Television (SARFT).

Some of the world's largest media organizations - News Corp. and Viacom not least among them - have repeatedly attempted to work around the letter of the law, only to find themselves each time face-to-face with the law's intent in the form of agitated, vengeful aparatchiks.

The vast majority of the air time and cable bandwidth available to the operators remains unfilled, hampered by party-enforced restrictions on the local creation of programs and import of content. And value-added services? Cable is rapidly losing out to the Internet and mobile.

Indeed, with operators eking out an operational living from the narrow, shallow stream of subscription revenues and their shares of advertising, they can barely contemplate investing in the network upgrades that would enable them to provide the premium content and value-added services that not only don't exist, but are unlikely to leap into existence as long as the industry is constrained from taking outside investment.

Are there experiments taking place in high-definition television, IPTV, digital, and premium channels? Sure. But these experiments and others like them have been going on for over a decade. And the government seems content to allow experiments to continue, but commercial rollouts have yet to happen.

There is more to it, of course, but that's the gist.

The painful consensus of the panel was that among the multitude of Chinese national treasures we evil foreigners want to get our claws into, the cable TV business is not only among the least accessible, it is also among the least appealing.

Jeremy Goldkorn asked me if I had money to invest in cable television in China, what would I invest in. I wasn't much of a sport. I told the truth: if I had money to invest, the last place in China I would invest it is cable TV.

The End of Cable

Cable television will continue to lumber along for some time in the future, for a couple of reasons. First, the growing appetite for television advertising time - ANY television advertising time - will ensure that revenues continue to pace economic growth. Second, China's urbanization plays right into the hands of cable operators, although returns will decline as they make investments to service the growing urban working class.

But unless something significant changes about the way the sector is regulated, at some point in the future, things are going to turn ugly for the operators. With no means at their disposal of significantly improving revenue streams or financing the hardware that would enable new revenues, cable will become what radio and terrestrial television are today - lowest common denominator entertainment. It's what everyone will have, but everyone will want more.

From a macro-policy level, the course of action that makes the most sense, that will allow the country to get the most out of its cable networks and to use them the way they are most needed, is a radical one:

• Set a basis for fairly valuing the networks.

• Have the local municipalities and the provinces sell them to the telcos after the anticipated round of telecommunications industry restructuring is complete.

• Separate out the channel production and advertising sales functions, spinning them into independent entities that will continue to be regulated by SARFT and the Party.

• Lay out must-carry regulations that ensure that current channels have grandfathered carriage.

• Let the telcos invest in the networks as both programming delivery and service delivery systems, parallel with other broadband but aimed at consumers who want alacarte services, not raw Internet coming into their TVs.

Is this a radical solution? You betcha.

Will it happen tomorrow? No.

Is this the likely eventual fate of the cable networks? Absolutely.

Cross-post: Whither to stash the great haul of China

Sunflower Tower, Beijing 
Grokking wind chill 
1320 hrs.

China has financed a huge part of the American consumer's borrow-and-spend spree of the last two decades, to the point where the doomsayers are suggesting that the U.S. has in effect mortgaged its future - both economic and political - in return for a few shiny trinkets.

At the same time, of course, the Chinese look at the Blackstone fiasco and the sub-prime meltdown and wonder if they are the ones being played for suckers, watching their invested dollars disappear as the dollar plunges and the American financial system looks a lot less stable than it once did.

James Fallows, sophomore China-hand and probably one of the most astute observers of the American political system, has jumped on the issue in his piece in The Atlantic this month, "The $1.4 Trillion Question." Well worth the read, it provides grist for anyone who wants to understand why (although not "how") the nature of the Sino-American relationship must change (and soon) and what that is going to mean for American lifestyles and for the men responsible for a the world's largest hoard of cash.

Here's what gets me. Warren Buffett's company Berkshire-Hathaway piles up $1 billion a month in excess cash, and Warren says he has problems figuring out where to effectively invest that. And he's arguably the smartest guy in the game. The people at China Investment Corporation have a US$1.4 trillion pile of money that is growing at an estimated $1 billion a day.

Fallows makes the point that China's well educated, brilliant, and determined financial leaders want very much to do a great job with this cash. What is clear to us here in the Hutong is that they are going to be writing an entirely new chapter in the history of investing as they attempt to do so.

Cross-post: Confucian schools and the quest for values

Starbucks Guomao 2 
Turn the Music Down
1121 hrs.

Maureen Fan from the Post did a profile of Luo Yu, a Chinese entrepreneur who has set aside his businesses and is focusing on running courses designed to instill traditional Chinese values into the children of China's newly-prosperous entrepreneurs.

We are going to see more of this kind of thing in the coming years. The Chinese people have had their moral codes stripped from them twice in the past century - once when Confucianism was tossed out the door in 1949, and then again when Maoism gradually fell out of favor in the wake of the Cultural Revolution.

What this has left the Chinese people is a moral code based on two of Deng Xiaoping's most famous utterances:

1. To get rich is glorious.

2. It doesn't matter if the cat is black or white, as long as it catches mice.

In other words, do whatever it takes to get rich.

Even a hardcore secular humanist should agree that this is a horribly inadequate moral and ethical basis on which to build a "harmonious society."

I suspect many parents will head in the direction of neo-Confucian schools like Mr. Luo's, and still others will turn to Buddhism and even Christianity, and that the government will be happily complicit in this process. It may not be politically correct for a senior member of the Communist Party to say that China's people need to have a spiritual aspect to their lives, but you can bet they're thinking it.

Something else we can look forward to: a growing national debate on what constitutes "Chinese Values," and an effort to create a secular cannon of Chinese morality cobbled from Confucianism, Daoism, and the more enlightened aspects of Chinese revolutionary thought (from Sun Yat-Sen through Jiang Zemin.)

Cross-post: Causal Marketing

In the Hutong 
Would you like fries with that humbuger? 
1704 hrs.

I regularly get questions from companies, practitioners, and NGOs about best practices for corporate social responsibility in China, mostly because it's an area about which I harbor some fairly strong opinions.

One of my biggest is peeves is this: there is a thin but important line between true corporate social responsibility and community relations tied to marketing goals. There is nothing wrong with either CSR or what is known as "cause marketing;" the problem comes when the thin line disappears, and a company will try to categorize the latter as the former.

Self-serving behavior like that tends to ruin a company's credibility, and to add to the dormant cynicism the general public maintains about the very idea of a company doing anything socially responsible.

That said, I'm a big fan of cause marketing when appropriately labeled, and I think companies in China (both foreign and local) do far too little of it. Given the decline in the effectiveness of TV advertising, I suspect both marketers and agencies are going to do a lot more of it.

What companies should be doing is defining CSR and cause marketing very clearly clearly and handling them separately.

Jeremy Nedelka at 1:1 Magazine (registration required) did an excellent cause marketing case study, including five rules for successful cause marketing according to David Hessekiel at the Cause Marketing Forum. The two articles are a good introduction to the topic.

What I love about the five rules is that all of them apply in China:

1. Set goals, knowing what you want to achieve going in;

2. Commit resources, because good intentions are no substitute for planning, budgets, and implementation;

3. Find a cause that has a clear, intuitive link to your core business or competency;

4. Search for models in what other companies have done before;

5. Expect results because solid cause marketing builds an emotional tie between customers

I have a few to add, though, because of a few issues I have seen crop up here in the PRC:

6. Cause marketing is no substitute for CSR. You need to do both. Make sure they are handled by separate teams and have clearly defined (and different) goals.

7. Don't be a cause-a-week company. Stick to one cause for a full marketing cycle of 12-18 months at least, and longer if possible.

8. Find a cause that is meaningful to people in China, not just to your CEO.

9. Cause marketing in China is virgin territory, so don't restrict yourself to what other companies in China have done.

10. Olympic sponsorships are not a great example of cause marketing, unless they are executed with a particular challenge in mind.

11. When your relationship with a cause wraps up, leave everyone smiling.

Shave a little of that TV budget, guys, and put it toward cause marketing. CCTV won't miss it, and you could put it to far better use than paying for fancy office towers for public broadcasters.

Cross-post: The Big Easy and Government Farkage

Starbucks China World 1 
Just anotha Maniq Mundeh 
1115 hrs.

Doing research for my book on innovation in China has really underscored what I call The Government Farkage Factor, or the extent to which government funding, direction, or primary role in any sizable development project is almost an a priori guarantee of graft, wastage, and failure. While I am no longer convinced that the private sector has an answer for every major problem, it is pretty clear that most serious development challenges demand an intelligent response from a balance of government, commercial, and non-governmental entities.

The New Orleans Example

The city of New Orleans continues in its role as the worlds preeminent development petri-dish because it is one of those places where all of the other factors have been eliminated and we can watch the various forces contend with each other in an effort to revive an entire political/economic entity. While most coverage has concentrated on the failures of various levels of government (municipal, parish, state, and national) first prepare for disaster, then to clean, repair, revitalize and fortify New Orleans in its wake, several reports have surfaced in the last month that point to the much-ignored but all critical role of other players in what is, basically, a problem of development.

The first I heard was a report on PBS's excellent NewsHour with Jim Lehrer about people who have moved to New Orleans on their own for whatever reason to start a new life. They're called "pioneers."

Second, while catching up on my NPR podcasts, this excellent report by Eve Abrams covers the beginnings of an effort of New Orleans residents to take on recovery tasks on their own.

The third was a speech at the University of Chicago Graduate School of Business by Jack McGuire, CEO of the American Red Cross, who talked with the frankness of a former corporate CEO of the ability of NGOs to respond to challenges more effectively than government. McGuire basically had to rapidly expand the Red Cross to help catch the ball fumbled so badly by the government. It wasn't pretty, but they did it.

Finally, there is an excellent article in BusinessWeek by John Tozzi who talks about the role entrepreneurs are playing to get the city back up on its feet again.

Takeaways

There are entire syllabi of lessons to be learned from New Orleans, but my take away vis-a-vis China is that it is not only more evidence of the very real limits of government in development, it is also (and more importantly) a lesson in the very wide range of forces that have to come into a situation - often of their own volition - in order to make it better.

Cross-post: China is going gray

Maya Alexandri has written a superb review of a recent government study on China's gray economy. The study claims that urban residents in China generate and earn an estimated RMB 4.4 trillion in grey income. Putting that number into perspective, that's about the size of the current defense budget of the United States.

Let's analyze those numbers for a moment. Figuring that China has approximately 300 million urban residents, that's RMB 14,667 in underground spending/earnings PER urban resident each year. While US$ 1920 per year may not sound like a lot, it represents a figure that is 25% larger than what the National Bureau of Statistics reported for per-capita urban income in 2006.

This means that urban income is at least understated by 25% in government statistics, and if the NBS is not taking into account the gray economy (which it doesn't look like they have,) urban incomes in China could well be underestimated by 50% or more.

In a day when there is a significant battle among economists as to exactly how much purchasing power China's urban residents have, this discrepancy could be pivotal in the debate.

Cross-post: We love the towns, the towns that go "boom."

Superb article by Peter Hessler, with photos by Mark Leong, in the June National Geographic (viewable onlinehere) that does the best job describing China's industrial entrepreneurs through a close-up of the heart of China's Horatio Algerism, Wenzhou.

I've been hearing and reading bits and pieces of apocrypha about Wenzhou for years. This article really pulled it all together.

Cross-post: Barbarians at the Gate and Private Equity's Rule-Set Reset

With the stack of books on my desk that await my attention, I don't know what propelled me to take the time to revisit Bryan Burrough and John Helyar's outstanding Barbarians at the Gate. But given what is happening in China's financial markets, I'm glad I did.

If you're not familiar with the work, Barbarians at the Gate is an engrossing, deeply entertaining telling of the 1988 saga of how the wealthy, cosseted management team of RJR Nabisco tried to buy the company from its shareholders, only to watch the buy-out turn into a vicious battle to control the company. More than the story of a single company, the book is a case study of what happens when the predatory forces of what Thomas Friedman calls "the financial herd" encounter large corporations arguably awash in inefficiency and waste.

Despite this being a book written by two Wall Street Journal reporters, none of the players comes out of this looking particularly good. The book also calls attention to the political debate surrounding mergers, acquisitions, and private capital, and in the end underscores that both sides have a point. The financial tools that enable these transactions can be used for good or ill.

Used for good, they can unlock the assets and hidden profits of a moribund corporation to the benefit of employees, shareholders, and broader community.

Used for ill they can be used to perform the legalized equivalent of what wise guys in the Syndicate used to call a "bust-out," or the systematic transfer of company assets into the pockets of a few individuals, followed by bankruptcy.

Nearly three decades after Michael Millken raised the much maligned junk bond to the level of high finance, launching a wave of mergers, acquisitions, buy-outs, spin-offs, and bust-outs that changed the face of capitalism. In that time, business in the United States (and to a lesser extent, Europe) have watched the systematic dismantling of the industrial conglomerates created in the wake of World War II.

As a result, people running public companies in America think a bit differently than they did three decades ago. Partly as a result of these financial machinations, American businesses are once again globally competitive, after a very long period of time in the late 1970s and throughout the 1980s when we were all questioning if they would ever be so again.

Which brings us to China.

Barbarians at the Jianguomen

Today, the people making the policies that affect China's financial services industry are weighing the pros and cons of allowing just that sort of "creative destruction" to take place in China. There is a lot to argue for it - and a lot to argue against it.

On the pro side, the guys in Zhongnanhai understand that waste, inefficiency, graft, and corruption are rife in major Chinese enterprise, and they all profess a desire to end that and create a host of globally competitive Chinese enterprises. They see there is a role for government to play in that process, a role for the market, and a role for financial markets.

Yet in the face of the public history of the financial industry of the last 30 years, you understand why China's leaders hesitate at the brink of unleashing such a wave of Schumpeterian mass destruction. Especially when in their eyes that effort carries the prospect of millions of downsized Chinese workers and a host of accompanying political and social problems, and especially when allowing The Herd to fill their pockets in the process implies some politically unsavory images in a land that remains at least nominally communist.

No senior official wants to preside over an industry where an RJR Nabisco-type fiasco is taking place. In fact, China's leaders, bureaucrats, and cadres are mortally afraid of allowing any transaction that might generate the least significant public concern, media attention, or political outcry. Imagine for a minute being a Communist Party cadre reading Barbarians at the Gate one evening before bed, then the next day having to sit down with a group of foreign investors looking to buy a major Chinese business. How could you notbe concerned, if not terrified, especially as another major financial firm seems to set up shop in Beijing, Shanghai, or Hong Kong each week?

Kinder, Gentler Barbarians?

As a corporate communications specialist, a certified spin-doctor, you would expect me to say that any financial firm seeking to engage in creative destruction in China has got to make sure it positions its intentions in China correctly, delivering just the right messages to China's alerted (if not alarmed) bureaucrats to assure them that you are looking out for their best interests.

I would - if it were that simple. It ain't.

While I am a big fan of saying that business in China is fundamentally the same as doing business anywhere else, unless you understand what those fundamentals are, you're lost in China.

One of the fundamentals that has enabled the immense success of the financial services industry in the U.S. is the understanding that while strategies remain constant, tactics - how you execute your purchase, integration, and sale of corporate assets - depends on the commercial and political environment and how it is evolving.

There are some extraordinarily bright people at private equity giant Carlyle, people who understand how messages need to be delivered. And yet Carlyle's purchase of a controlling interest in heavy-equipment maker Xugong demonstrates that the financial services

China demands a different type of execution, one that addresses the concerns of regulators and does not incite - or carry the prospect of - significant political backlash. China's regulators are looking for companies that understand the delicate line they walk between charting the nation's future and taking care of the social and political issues they must deal with today.

In short, rather than waiting to hear messages, policy makers are looking for evidence that someone in the growing procession of private equity firms understands the political and social challenges of letting foreigners buy up China's most promising business, and are willing to go out of their way to address them - in advance.

Because if they haven't read Barbarians at the Gate, or something like it, they will soon.

Cross-post: Debunking the white tornado

When I was a kid, a large consumer products company ran a TV ad campaign for it's line of detergents, likening the effect of the product to a white tornado, a great whirlwind that would sweep in and clean anything, erasing even the most embedded filth. Perhaps it is this kind of marketing that contributes to an apparent belief among foreigners, particularly Americans, that adding something clean to something filthy makes everything clean.

I call this belief The Great White Tornado Theory.

The Great White Tornado Theory is used most often in China by advocates of foreign participation in China's financial industry. Listening to the tales of embezzlement, corruption, and malfeasance among China's banks, securities brokerages, and other sectors, executives of international firms shake their heads, tut-tut sadly, and remind media, policymakers, and each other that if ethically managed (read "foreign") companies were allowed to fully participate in the market, by competitive force and dint of example they would help eliminate unsavory practices.

It's an attractive theory, and as an advocate of greater competitiveness in China, I want to agree. A lot of my friends do, as do many people whom I respect deeply.

But both the theory and those who expound it have some credibility problems with Chinese audiences and impartial observers.

What're We Doing Here?

Let's say for a moment China were to allow open foreign participation in, say, the securities brokerage sector. Once we get past the rhetoric and the high-minded ideals, foreign firms are not coming to China to clean the place up - they're coming to make money. After making investments in staff, high-priced offices, and years of lobbying, headquarters in New York, London, or Tokyo are not going to be telling their China teams "okay, guys, go out there and help build an ethical market." No, the word from HQ is going to be "get out there and start making us a mint, or we'll fire you and find somebody who will."

The pressure to perform will be intense, and the competition - intensified by the arrival of foreigners - will make performing extremely difficult. The pressure to engage in common but unsavory practices to get business and drive results will be intense. In such a cauldron, the question of making the ethical choice and the profitable one will not come down to the name on the door or the pedigree of the firm - it will come down to the character of the individuals making those choices, and to how willing firms will be to sacrifice profits for ethics.

If the situation in other industries and places is anything to go by, the prognosis is not good.

Doing Like the Romans

The experience of other industries in China suggests the path that foreign securities firms might take.

There are those who believe that only a very limited number of foreign firms engage in unethical practices in China, and there are others who have confided with me that they believe it impossible to make a profit in China without bending your morality a bit - the system is simply rigged against that. In reality, China can be extremely hard on ethical corporate practices. As Peter Goodman wrote in The Washington Post last August:

"American business leaders often describe their China operations idealistically, suggesting that their presence here will compel Chinese competitors to adopt more ethical business practices. But in one key regard, the dynamic operates in reverse, with U.S. companies adopting Chinese-style tactics to secure sales, as they compete in a market in which Communist Party officials routinely control businesses, and purchasing agents consider kickbacks part of their salary.

Managers of U.S. companies say they are caught in a dilemna: They are answerable to shareholders on Wall Street and home offices that demand a piece of an increasingly lucrative Chinese market. Yet they are also held to account at home by the Department of Justice and the SEC."

In short, when in Rome, companies are not acting like the Greeks. Foreign firms in the telecommunications, medical equipment, airport security, software, and computer hardware industries have all been accused of, have admitted, and/or have been fined for practices that are not only unethical but are indeed illegal in the U.S.

For the finance industry, is there anything to suggest that the record would be different?

The Record Elsewhere

A scan over the checkered history of the financial industries in the U.S. over the past two decades does nothing to suggest that there is something about an international institution that inhibits impropriety. The savings-and-loan scandal from the late 1980s, the insider-trading convictions of people like Ivan Boesky, the tainting of research by investment bankers, the growing options pricing scandal, boiler rooms, pump-and-dump schemes...all evidence drawn from the front pages of America's largest newspapers, all representing ethical lapses in finance, and all taking place under the aegis of the toughest regulatory system in the world.

Taking the show on the road hasn't helped. Failures in ethics and systemic controls at places like Morgan Stanley Japan Securities and Goldman Sachs Japan make clear that financial firms are not above rolling around in the mud with the locals like Mitsubishi Securities and the Murakami Fund in the name of profits. Indeed, if Japan is any model, one could argue that it is not foreigners who will clean up a market, but local regulators with sufficient political air cover to do the right thing.

So again, I ask - if foreign financial firms can find themselves in hot water at home for not doing the right thing, what evidence is there that they will have a cleansing effect on China.

Right Impulse. Wrong Reason.

Foreign participation in China's financial sectors will be a good thing for a lot of reasons - it will increase competition, diversify services, and force everyone to work harder for the customer's business. The institutional capital and investment mentality the foreigners bring with them should do much to stabilize the punter-driven technically-based markets, and possibly even bring some accountability to bear on listed companies.

Creating a cleaner market, however, is not one of those reasons.

The government knows all of this - there is a growing understanding among regulators that a well managed market requires an independent third-party overseer with prosecutorial powers in addition to whatever self-regulation can be put into place. (That's not radical, anti-free market thinking, by the way - that's theSecurities Exchange Act of 1934.)

For that reason, anyone who suggests to a government official in China that foreign participation will have a cleansing effect on China's financial industry is merely flushing his own credibility down the toilet. Drop the argument already - it weakens a case that is strong enough on its own merits.

Nota Bene

The fact that The Great White Tornado Theory is specious and a lousy argument for open financial markets does not release financial institutions from the implicit obligation to do well and do good. Do not come to Rome and do as the Romans - come to Beijing with the full cognizance that the ability to know right from wrong - and to act on that knowledge - is a long-term competitive advantage.

Chinese companies and individuals are not going to be comfortable with placing their financial futures in the hands of institutions who engage in nefarious practices. All a foreign firm can offer today that a Chinese firm cannot is trust, the comfort that a customer is putting his faith in a professional whose ethics are above question. Lose that, and the Chinese financial industry will be a rat race and the foreign firms will be the first targets when the regulators grow new teeth.

Originally published 5 October 2006