In order to maintain confidence in their ability to govern, the Chinese Communist Party needs to deliver prosperity and employment to countryside and country, not just the fast-developing coastal cities.  Much of the current GDP growth was built on a policy of promoting exports and financing it with foreign direct investment.  The result has been an impressive transfer of knowledge, technology and skills to a new generation of workers.  It has enabled manufacturers to quickly scale up the quality and innovation ladder and leverage the enormous potential of production automation and information technology.  This has provided rich rewards to the owners of capital, including many multinationals that earn a majority share of the export profits.

The recession in the developed world is dampening demand for many of China’s consumer exports.  Much of the Government’s stimulus investment in infrastructure and directed banking lending has gone into fueling substantial overcapacity in heavy industry.  There is a strong argument for boosting the road and rail network in order to support future industrial growth.  However, China’s banks are not geared up towards the effective allocation of capital to industry.  Too often the credit ends up as a capacity overhang in heavy industry, in the real estate market or other assets like commodities.  This is driving up asset prices and adding to imbalances in the economy that makes it even harder to implement structural change without impacting growth.

What is missing from all of this is Chinese private industry.  When China took on the mammoth task of restructuring the large State-Owned Enterprise, officials cherry-picked industry sectors believed to be “strategic” to the national interest.  Large capital-intensive industries like banking and finance, metals, minerals, energy and chemicals were kept for state-owned giants to champion global growth from a position of domestic market dominance.  Other industries were left to private Chinese and foreign enterprise.  A few hybrid exceptions exist, most notably automotive which remains partially regulated with a wide playing field of state-owned producers with foreign JVs like SAIC and FAW and private Chinese firms such as Cherry and Geely.  Since restructuring the SOEs, there has been relatively little privatisation.  And many private companies are now being re-nationalised under a phenomenon known as Guo Jin, Min Tui or “The state advances and private retreats.”  The Government denies this is an overt policy, yet there have been many instances of state-owned companies acquiring private companies including Rizhao Steel, Mengniu dairies and large sections of the Shanxi coal mining industry.

Some of this may be spurred by previous lax health and safety regulation of private enterprise, with recent problems specifically in milk production and mining.  However, the regulation of industry through nationalization does not have a strong track record in the history of economic development.  It is unlikely that this approach will generate the best combination of safety, innovation and growth.

Meanwhile, state-owned banks are accumulating loans that will be backed by under-performing or speculative assets.  Private industry is starved of capital and faces fierce competition from international companies in the Chinese domestic market.   Many foreign firms have been operating in China for long enough to have a cost base that is highly competitive in their market segment.  The domestic consumer economy is largely open and as Chinese consumers demand higher quality products, they will more often reach for foreign brands.

 If private Chinese companies are to innovate and develop their own brands, they will need access to the huge potential source of capital in savings accounts.  This can be done through three main channels: banking lending, capital markets or profits from consumer spending.  It is clear that China’s banks are not yet equipped to do this without the push of policy.  The capital markets lack transparency, governance and trade only a fraction of the equity.  There is a lot of expectancy for the consumer to open their wallets and release this savings glut into the economy.  Much of this spending relies on confidence in the government to reform welfare and healthcare so that people do not feel they need to hoard for an uncertain future.

Commentators, central bankers, politicians and analysts are urging this do so for right and wrong reasons. Despite what US Congressmen would have you believe, China’s control of the RMB is not part of some dastardly plot by it to take over the world at the sufferance of the US exporter. It is a fact that a revaluation of 10-20% would not have much of an impact on the US trade deficit: China is far too deeply embedded in the global supply-chain. Most of the profits derived from China’s exports to the US are taken by American companies, so the US economy is in fact a beneficiary in the process. Furthermore, a large proportion of the value of China’s exports is based on imported content. The high-value components that go into the products are mostly sourced from other countries. If the RMB appreciates, then the cost of this imported content goes down and offsets the rise in export prices. In fact, the value-added content of China’s trade only accounts for around 17% of GDP growth. So, the Chinese economy is much less dependent on exports than is commonly believed.

So why does the People’s Bank of China so staunchly resist all calls to let the RMB appreciate? Well, one of the reasons is that so many people are calling for the RMB to appreciate. If you want the Chinese government to cooperate, it is wise not to broadcast your desire far and wide. There will never be action if it is seen that China is bending to the pressure of rich country governments in the West. Diplomats may well counter that they have already tried the quiet approach and it has not got them very far. There is some truth to this. Even though the RMB has fallen by around 18% in the four years to June 2008, it has not moved since then.

A bigger fear than losing face is the effect of hot money. China has attracted tens of billions of dollars from private, corporate and institutional investors who are betting on the Yuan’s eventual rise. This money sits in China as RMB-denominated assets, and given the pittance of a savings rate that is earned from bank deposits, much of this money has been funneled into the property market. As soon as these hot money investors believe that they have seen all the appreciation they are going to get in the short term, this money will flood out, risking a collapse in the housing market. So, keeping the world guessing about RMB appreciation is not just a frustrating example of Chinese inscrutability. It is designed to prevent more money being attracted by an expected appreciation and a sudden departure afterwards that sucks the air out of the real estate bubble.

Another reason why the RMB is so tightly managed is likely to be the powerful influence that export business has with China’s government and the Communist Party. Supporting China’s exporters is seen as something of a national duty, and there are leagues of officials and bosses who are aching for Chinese companies to follow Japanese and South Korean companies to world domination. The problem is that China’s economy does not need more exports, it needs domestic consumer growth. And this consumption has to be directed towards imports as well as domestic production. A more valuable RMB will make exports more expensive and imports cheaper. It is exactly this rebalancing that is needed to get past the reliance on heavy industry and into the more effective growth engine of consumption and services.

Manufacturing is very capital-intensive and an inefficient way of creating jobs and stimulating the economy.  Export manufacturing relies on imports, yet the profit from those trades is all too much going to foreign multi-nationals. This lending policy of shoveling credit into production over-capacity and an exchange rate policy supporting uncompetitive exporters are highly dangerous. Sooner or later, the economy will have to rebalance and the greater the imbalance, the more unstable the rebalancing will be.

At the core of this dilemma is the fact that China’s economy is very open, much more open than any other developing country at a similar stage of development.  There are few Chinese companies who have the potential to be a Toyota, a Panasonic or a Samsung. This is because the state is starving private enterprise of capital whilst force-feeding state-owned companies with lending that they struggle to invest effectively. The RMB is a crude mechanism for protecting domestic markets from imported goods, yet it is the main weapon they have.

The fate of the RMB is intricately tied in with the distribution of capital from the legions of savers to consumers and companies who need credit and can put it to work in the domestic economy. The recent government stimulus has largely been directed into infrastructure (necessary and largely effective for long term growth) and heavy industry like steel, chemicals and cement (unnecessary and contributing to huge over-capacity).

The sad old truth is that government officials anywhere in the world are terrible at judging where investment capital should be channeled. Private industry and deregulated capital markets do this much better. This story has been proven time and again around the industrialising world. China’s problem is that the banks are not capable of effectively allocating capital and managing risk. The stock-markets lack transparency and are too thinly traded to establish proper pricing.

China’s industrial policy is far too biased towards state-owned companies and negligent towards private enterprise. In my next and final post, I will explore this and look at the chances for emergence of China’s global corporate champions.

Technology has enabled mankind to do many wonderful things and one of those is a global supply-chain.  The foundation of economics is built on the assumption of comparative advantage.  This means that countries, individuals and companies have things that they do well and others that they do not so well.  Everyone should focus on what they do best and outsource everything else. 

Now, it is becoming clear that China does manufacturing pretty well. This is not simply because of cheap labour; the direct labour content of most consumer products is much less than 10 percent. I think there are two main reasons that China is good at manufacturing: First, it is a large industrialising country with a huge home market.  This keeps the focus on secondary industry and drives input costs down.  Second, I think that many Chinese people naturally have the right blend of engineering and enterprise that is needed for strong manufacturing growth.  It helps that China’s rise coincided with a boom in standardised parts, low-cost production automation, global freight and information technology that enables manufacturing to be outsourced across a large scale.

So, technology enables the consumer, product creator and manufacturer to be located in different corners of the world. The skills required to market, distribute and retail to the consumer can be located in a different country than those needed to create product designs. And the specialisation of manufacturing can be located in a third country.  This is all good stuff, as long as it is a fair deal.  Goods are exchanged for money which represents the cost of the product plus a reasonable profit.

The problem with trade and the environment is that the cost of most products is not fully absorbed.  It is debatable whether any products are being exported at less than their direct cost of materials, labour and overhead. This discussion on dumping justifies another post of its own. I am talking here about environmental cost, part of what economists call externalities.

In a perfect world, a company would bear the full environmental cost of manufacturing the product and pass it on to the consumer.  This would encourage consumers to go and buy products that perform as well or better, but with a lower environmental impact in production.  In practice, this is difficult to measure and almost impossible to enforce.  This is true for anywhere in the world, before you even consider the challenges in China.  So products are flying out of China’s ports that are only partially cost-absorbed and China’s population bears this cost in health, environmental degradation, reduced growth and higher taxes.

Those in developed countries are no doubt proud of whatever improvements to the environment that have come from closing down heavy industry.  No-one in their right mind would wish to go back to the conditions of Victorian London or 1970s Cleveland, for example.  Nevertheless, it is easily forgotten that much of the plastics, chemical and metals that are consumed are now produced in China.  So too the products that are made with them.  Demand for these materials and products have not diminished – to the contrary it has never been higher.

The latest example of this is solar panels.  It takes a lot of coal to make a single solar pane l- the process for manufacturing the raw material, polysilicon, and the panel itself is hugely energy intensive.  There are also nasty chemicals that come out of the process as waste, such as trichlorosilane, mercury and chlorine.

In the US it is claimed that a solar panel takes between 1 and 2.5 years of continuous operation to pay back the carbon dioxide emissions in making it.  There is simply no payback for the chemical nasties.  Now you have to factor into the calculation the old, inefficient equipment that is used in many of the factories that produce polysilicon in China. And then consider that many of China’s panels are sent to Germany where a distorted system of subsidies is sucking much of the world’s supply for solar panels into one of the least sunny places on the globe.  It has been estimated that a solar panel made in China can take up to 20 years to pay back its carbon emissions.  The stated lifetime of a panel is 30 years, yet I don’t know anybody who seriously believes that a panel made with today’s technology will still be operating at peak performance in 2030.

All this goes to show China’s dilemma.  Its export and manufacturing business model is creating growth, yet is generating huge externalities. Of course, in many areas the domestic economy is even more polluting, resource inefficient and dangerous to health than export.  Yet at least the domestic system is a closed loop with a single consumer market, tax and regulatory regime.

And much of this export is not particularly profitable or good for growth. China only derives around 18 percent of its GDP from exports as much of the valuable components are imported and much more than half the profits go to multinational companies from Japan, Europe and America.

Public anger about environmental degradation and inequality is the number one worry that keeps Communist Party leadership awake at night.  They have one Get-Out-of-Jail-Free card that they play if it looks like this anger will turn towards Beijing:  It is called “Blame the Foreigner”.  There is a real risk of rampant nationalism emerging in the future.  The facts that I have outlined here provide fuel to that fire.  There is little sign of this becoming a flashpoint at the moment; however if the government is not able to get this imbalance fixed then it could well flare up and become a dangerous blaze. The resulting smoke may blow over many a border.

Much of this is a byproduct of the transformation to a market economy. There is no data before about 1980 and I would not trust much of the data about or from China before 1990, so it is highly possible that in reality this is a U-Shape trend rather than an upwards one. It is also worth noting that China only just overtook the US in 2006, whose own inequality has also been increasing since the 1970s and is now at a level normally associated with developing countries.

Wikipedia has a useful (yet slightly overloaded) comparison chart from different countries here.

It is not just the uneven income distribution across China’s population that is the problem: it is the combination with a large imbalance in regional growth and endemic corruption in local government. The major development areas around the coastline have been the engine for China’s economic and trade performance. The hinterland and rural areas of Central, North and West China have been left behind to a large extent.  

Much of this is a consequence of the drive towards foreign direct investment and export growth (see earlier post). Coastal areas have had more contact with the outside world and are natural choices for export, given the access to shipping. However the 1990s saw extensive overinvestment in the coastal areas and underinvestment in the Centre, West and North. The solution for both government officials and factory bosses was to allow workers from inland to come into the fast developing cities like Shanghai and Shenzhen on a tightly controlled residence system. This was intended to keep a lid on wages and provide investors with a long term supply of cheap labour.

I have seen countless business projections in the early 2000s that blithely assumed direct labour costs to remain flat for years. Many business owners, particularly in the South of China, boasted of having cheap labour “on tap” for the foreseeable future. Well, it didn’t work that way and many of those businesses have gone bust or relocated elsewhere. 

Anyway, despite the billions of RMB in remittances that have been sent back to the countryside, the rural and hinterland areas still lack something much more important to economic activity: land rights. The coastal areas have seen the fruits (yet not so much pain) from a property boom based on selling off land leases on the cheap to developers who in turn sell buildings and apartments off on the cheap to individuals and companies. Cash sloshes around the local economy everyone makes out like bandits. Not so in the rural areas, where good farmers are unable to scale up production across larger lots and bad farmers are afraid to move on in case they lose their occupation.

So, when land is taken without proper compensation by corrupt officials and their cronies who pocket the proceeds, then people get mad. And the peasants are truly revolting. There are ten-thousands of protests and uprisings that turn violent around the regions in China. It is difficult to get accurate figures as journalists are prevented from accessing such areas, in spite of promises made for reporting freedom for the international press.

The long arm of the Central government doesn’t quite reach as far as it would like to, or as far as it needs to, in order to stamp out this corruption. What is required is a legal reform that can unlock the “dead capital” from underneath tenants who cannot trade their land rights and move on to more productive endeavours. 

Income inequality, regional imbalances and corruption combine to put serious pressure on the Zhongnanhai leadership to reform the legal system and do for the rural population what has been done for the urbanites. There is scant sign that this is happening as fast as it should, or even at all. There are even some officials who believe that repression is the answer and peasants should shut up and be obedient to their lords and masters. No doubt they recall that the last two challenges to the Qing Dynasty, the Taiping and Boxer rebellions, came from provincials who were discontent with inequality and resented foreigners who were acquiring influence and power in Beijing and Shanghai. It seems, however, they forget that neither of those events turned out well for the palace rulers.

Rural uprising due to inequality, land seizure and environmental degradation is probably the single biggest problem that keeps China’s leaders up at night. In the next post we can explore the environmental problem and along the way we might see how green technology might just be another way for rich countries to export their pollution problems to China.

This is important for China, because historically its GDP growth has been skewed towards investment and exports to an unsustainable extent. The stimulus in government spending has been a stop-gap to keep the economy going, yet clearly this is no long term solution. China needs consumption to rebalance its growth mix.

Rebalancing is not the only reason for boosting consumer demand. The entire reason for China to pursue an aggressive growth policy has been about employment and increasing the standard of living for ordinary Chinese. About 20 years ago, the Communist Party struck a grand deal with citizens: don’t worry about decadent luxuries such as democracy and rights – leave us to run the country and we will guarantee you rising prosperity and keep a control on blatant corruption. This deal has worked remarkably well, as long as the economy keeps growing and creating jobs.

The restructuring of State-Owned Enterprises took tens of millions off the payroll. Although this programme did not do much for private indsutry (more on this guojin mintui phenomenon later), restructuring unprofitable enterprise left a hole that requires more than 2.5M jobs a year to fill. So, the push to exports and foreign investment was performed in order to create jobs. The most immediate and obvious way this has occurred is through manufacturing.

The problem is that manufacturing is a poor way of employing lots of unskilled people: it is capital-intensive. As a country industrialises, manufacturing is a fairly ruthless process of transferring wealth from labour to capital. Most of my clients in the manufacturing sector have a direct labour content of between five and ten percent of total product cost. The bulk of cost is in materials and overheads. So, as you go up the supply-chain from consumer goods to raw materials, the direct worker is getting a thin slice of this spending and the rest is going to skilled labour, owners of capital and government.

Services are far more labour-intensive, and much harder to outsource as China’s labour costs grow. Services are also essential for consumption. It takes much more financial, distribution and retail infrastructure for China-based manufacturers to get their product to domestic markets than it does to ship containers across the ocean to developed countries. It requires more research and development to originate and adapt products for developing countries than it does to replicate or contract to supply western and Japanese product designs.

Furthermore, the jobs that have been hit by the global downturn in China are low-value manufacturing that was largely undesirable anyway given environmental costs, pittance wages and razor thin margins. I believe the global recession was a convenient reason for the government to shut down much of that dirty, low-tech industry that could not survive with proper compliance to tax, environmental and labour regulations.

So it seems that job creation, prosperity, consumption and services go hand in hand. This is the route to a knowledge economy where China’s competitive advantage does not rely on sweat factory labour, but specialization in service-rich manufacturing, product development, engineering and distribution.  In order for this to happen, the domestic economy needs financial, retail and other services that assist with getting product to market and cash to consumer.

China’s long term prosperity will rely on the creation of a broad middle class that provides skilled and professional services to companies that are supplying demand at home and in a broad range of developed and developing countries. By diverting more income to labour instead of capital, the wealth of the country can grow evenly across all segments and combat the stark inequality that plagues China today.

Next post: inequalities of income across regions and social groups in China.

However, it is important to remember that raw GDP growth is not a complete measure of overall economic development and prosperity. China’s biggest concern should not be the quantity of growth, but its quality and how can it be improved and sustained.

I have six major concerns to the question of China’s growth quality:

1. Growth Mix
2. Labour Intensity
3. Income Equality
4. Environmental Costs
5. RMB and Capital Markets
6. State-Ownership of Industry

I can describe them all and how I think they link together over the next few posts.

Growth Mix

By definition, gross domestic product is the sum of consumption, investment, government spending and net exports. It follows that a high quality of GDP growth requires a good balance between the four areas. In the ten years 1995 to 2005, the government strategy for economic growth was to boost exports and encourage foreign direct investment. Money flooded into the country to be invested in fixed assets (mainly factories and production equipment). This export-centric policy left large parts of the economy highly exposed to the RMB rate and international demand, mainly from US. The orgy of foreign direct investment and export lending has left huge overcapacity in many segments of industry.

Then the sub-prime crisis came along and destroyed consumer demand with China’s biggest export customer. The resulting credit mess has dampened demand elsewhere around the globe. China had its own slowdown which was (somewhat) connected with the global recession (although more to do with the air coming out of China’s own housing bubble). To counteract this, the government embarked on a huge stimulus programme and this has a lot to do the current upturn in China’s growth figures. The big question for this spending spree is effectiveness and the impact that the liquidity and infrastructure will have on the rest of the economy.

So, out of four components we have three that have been major instruments of government policy. And in a large, centrally controlled economy like China’s those instruments are pretty damn blunt. With every local government throwing tax benefits at foreign investors and banks lending money to only “approved” export-related projects and not much else, it is easy to see the source of overinvestment.

An even bigger problem with the mix is that consumption is missing. This is by far the most important component of growth. Of course, this needs to be sustainable consumption with a debt burden that is under control. This is a lesson that America is now painfully discovering. Nevertheless, true economic power comes from imports far more than from exports and in the global economy, the consumer is king. China has enough savings to fund the biggest spending spree that the world has ever known. However, it is not as easy for the government to boost consumption. Even with negative real interest rates it is hard to prevent consumers and companies from hoarding their cash. For China’s consumers to spend, they need to have a deep sense of security about the future. Reform of healthcare and social security are far more important to this than the infrastructure boom and will take much longer to have an effect. This is why consumption represents a weakness in China’s growth and will do for some time to come.

In the next post, I will look at employment and explain why I think manufacturing and exports are a pretty lousy way to generate jobs in the economy.

The first questions were softballs, asking about cultural exchange and diversity.  They gave Obama a chance to demonstrate that great political tradition of answering a different question to the one asked.  Somehow he got onto the topic of climate change, giving airtime to a subject that is unlikely to see any actual progress in Copenhagen next month.

A later question was supposedly received through the internet by a businessman from Taiwan concerned about military proliferation across the Taiwan Strait.  It looked suspiciously like a device to jibe the US about arms sales to Taiwan.

The subject that seemed to generate the most media interest referred to internet censorship and the ‘Great Firewall of China’.  The fact that it came “through the website” of the US Embassy in China either meant it was placed by an expat frustrated by the lack of Facebook in China, or a diplomatic effort to open up press freedom in the Middle Kingdom.

This evolution of internet censorship in China is an interesting issue.  In 2002, Cisco Systems sold a large system of routers that enabled the government to block traffic.  Since then, the Great Firewall has operated with increasing levels of sophistication.  The Beijing Olympics demonstrated that the government could no longer get away with blocking international media sites.  Even outside world sporting events, China has become such a significant location that curbing BBC, CNN and other major news networks would place too much strain on China’s image and function.  Now, the majority of news stories from the major sources are freely accessible to anyone with a normal internet connection.

The censorship has turned to blogs and social media.  This distributed, decentralised method is much harder to control than network and portal news.  Even with the ten-thousands of network policemen that are at work at the Ministry of Public Security, it would be impossible to censor all of the content in blogs and other forms of social media.  It is much easier to simple block any site with the words “blog” in the title, keywords or page description.

The irony here is that much of the blog content out there is actually useful, practical information about technology and inspiring content on creative ideas that have absolutely nothing to do with China’s sensitive topics.  Sure, there are mountains of trivia, smut, insane rantings and deeply boring stuff about ordinary people.  However, the internet is now bringing a torrent of powerful information about everything that is not written by journalists, lobbyists, marketing people or snake-oil salesmen.  It is written by citizens, users, consumers and peers.  This makes it so much more valuable than conventional media because it is not designed to sell advertising, but generated by a passion and deep specialism and expertise in the subject.

The main motivation for blog censorship is much more to do with keeping Chinese bloggers under control than it is about keeping foreign content out.  The resources dedicated to policing international web content is tiny compared with the vast machine that is deployed to squash domestic commentary.  Foreign blogs could easily start to post content from Chinese bloggers and so it is much safer just to slam the door on all things bloggish.

More’s the pity.  Obama was quite clear about the benefits that he gained from social media.  After all, he rose up from first-time senator with no dynasty behind him to win the first billion dollar presidency.  And the critical extra funding did not come from corporate or K-Street, but individuals who donated through an ultra-effective, decentralised fund-raising machine.  Even more valuable than dollars were the hundreds of thousands of volunteers who went out into the field and did the kind of work that the Republicans could neither afford nor organise.

As China sits on her pile of (soon to be inflated) dollars, this is a message worth listening to.  The challenges that the Zhongnanhai administration face in the next few years have very little to do with financial resources and much more to do with public support.  Stimulus spending will only go so far in keeping the population happy.  The Beijing government will need to make some serious improvements in the quality of growth as well as the quantity.  This means addressing monstrous environmental problems, reforming the entire healthcare system and dealing with rampant corruption in provincial and local government.

Money alone will buy none of this.  This is why Obama’s message on internet freedom is important, not just for students who need to learn how to think but also for governments who need to learn how to listen.

Giant Pandas are native to China and have played their role in describing a gentle form of diplomacy.  However, the Dragon has long been the traditional representation of China.  As China develops as an economic and political force, it has appeared more frequently to characterise power and strength.

Anyone having grown up with European mythology will associate Dragons with a giant, rampant, fire-breathing beast that lives in a cave and terrifies the local villagers as they wait for a saviour who is brave enough to slay the creature.

The Chinese Dragon bears no malevolence. Rather it symbolises an auspicious power, particularly the control of rainfall and flooding.  So, this symbology might provide some background to the seemingly insatiable desire that government officials have to manipulate the weather.

The Beijing Weather Modification Office employs over 37,000 people across the country.  Their technique is to fire rockets that are loaded with silver iodide, a chemical that seeds clouds and brings on precipitation.  Silver iodide has a crystalline structure that is similar to ice and this stimulates the formation of ice crystals from vapour, pushing the cloud to rain. The stated intent of the Weather Modification bureau is to battle drought, aid firefighting or prevent hailstorms. This technique has been performed in both experiment and practice since 1995.

More recently, it has attracted attention as a way of ensuring favourable weather conditions for important events such as the 2008 Beijing Olympics opening ceremony and the October 1 National Day parade this year.  Now, it turns out that two recent bouts of heavy snowfall in the North of China were artificially induced as a result of weather manipulation.

This is causing understandable criticism: hundreds of flights have been cancelled and traffic brought to a standstill in Beijing.  There are reports of hundreds of deaths and serious injuries from collapsing roofs and traffic accidents across the northern provinces of Hebei, Henan, Shanxi and Shandong; and these are just the ones that get reported in the state media.

This criticism of weather manipulation is rising due to these recent events. It is likely that the collapse of schools and other buildings due to snowfall will generate blame towards shoddy construction standards and local government corruption. Similar concerns about building safety also caused controversy over the Sichuan earthquake in May 2008. 

Up until now, the central government leaders have managed to maintain the trust of the people. Citizens get angry about local government corruption and shabby services, yet believe that the central leadership has their best interests at heart. The last time heavy snowfall caused nationwide disruption to transportation and travel was during 2008 Chinese New Year. Prime Minister Wen Jia Bao was quick to appear at the scene and take a direct role in coordinating disaster relief.

Locals accept that the government in Beijing cannot be blamed for unfortunate weather patterns or earthquakes. They might even acknowledge that it takes time to clean up corrupt practices in the provinces. However, if it transpires that more weather-related disasters are the result of weather manipulation coordinated by a Beijing-based Weather Bureau, the controversy could extend to the central government and do much to threaten this delicate trust.

No, it is not Total Quality Management at China’s Railways. Or the launch of 360-Degree Feedback in the People’s Liberation Army.  It is Yum! Brands’ company-wide initiative that is now being rolled out world-wide. “Achieving Breakthrough Results” is an innovation programme that is being embraced by the top management of the company that owns fast food chains, including KFC, Taco Bell and Pizza Hut.

The Economist reports that Yum! Brands is implementing this methodology across the world. Before any recruitment consultants out there get too excited, the 1.4M people work in 112 countries around the world, not just in China. And the initiative is driven through the organisation from the top managers in the HQ.

The method was originally devised by John O’Keeffe, an ex-Proctor & Gamble executive. He had developed a training course that encouraged “a healthy dissatisfaction with the status quo” and sold it to Yum! China. This is an admirable goal and particularly welcome in a country where speaking out has not traditionally been rewarded. It seems that Yum! Brands’ management had adopted the methodology in an attempt to stimulate creative thinking. Fast-food franchises in China face a tricky challenge of balancing the brand image with the need to adapt a product to the tastes of the local market. 

Mr. O’Keeffe’s ideas have taken hold in Yum! and could plausibly be a contributing factor to the $469M in profit from the China operations in 2008. Certainly, the book KFC in China is a best seller and is prominently displayed in bookshops as a guide to getting it right in the China market. Dave Novak, Yum! CEO, is certainly impressed: he came across ABR in the China operation and is now applying it from the executive suite right down to the fat fryer.

This story is interesting to me as I have long believed that China’s competitive advantage does not arise from cheap labour. The core of China’s economic power is not the billions of people who will work for a few dollars a day. Yes, you heard right. China’s advantage is not based on low-cost labour.

China’s economic power is derived from Chinese people: relentless drive, astonishing resourcefulness and the vast potential of the local economy. Fast food is an industry that relies on cheap labour – some of the lowest wages in the developed world. Yet these are local jobs for local customers. Success demands an exacting level of creativity to adapt products and services that fit with local requirements, whilst delivering something new that justifies bigger margins in the cut-throat domestic market.

Achieving Breakthrough Results may have been born from a foreign management guru who gained his experience working at one of the world’s most admired companies. Yet it was application in the China division of Yum! that sparked the management will to drive it across the global organisation. I look forward to many more companies having their own cultural revolution with both Chinese and capitalist characteristics.

The name of this blog refers to the usual sources of information about trends and ideas in and around the Central Kingdom.  In some aspects China changes fast whilst in others things have remained constant for thousands of years.  In a country this diverse and complex, it is a challenge to get reliable information about what drives and resists the forces of change.  Those of us who are interested usually rely on the following three sources of intelligence.

The most persuasive and immediate is the first hand experience we get from living, working and dealing with China.  This is a school of hard knocks for those of us who run businesses here and we have experienced it all: the good, the bad and the ugly.  Nothing can replace first-hand experience; however it would be nice to sometimes learn lessons from others rather than always doing it the first time.

The second perspective offers a more varied source of information from anecdotes and stories that are told by our friends, customers, suppliers and colleagues.  This provides a glimpse into other organizations and situations and we get a sense of other peoples’ opinion on a given issue.  The trouble is that it is often restricted to certain industry areas or markets and can be a view slanted by the motivation and emotion of others.

These two views are supplemented with the third person in the form of media reports, news items and published research.  This third perspective is an essential element of market intelligence and it is well appreciated that there is more and more coverage of China in the world’s press, much of it from well-respected, thoughtful and balanced commentators.  However the growth of coverage is linked with the fact that China issues are becoming increasingly political.  Nowadays, there is hardly a topic in trade, economics or business that remains free from the tainted hand of special interest groups, lobbyists or the censor.  It is a fact that globalization is changing the lives of many people around the world and in the attempt to take sides much reporting is incomplete, biased or wrongheaded.

So, I offer my Fourth Perspective to you.  This is based on insight that comes from life in Shanghai and working across Asia, mostly in the industrializing areas that are the engine to China’s growth.  I do not suggest here that my own experience is necessarily any more valuable than that of others who operate here in China.  I do work in a wide range of industries and product markets and this means I can gain a broader experience than one who is restricted to a single line of business. We consultants are in the business of trading ideas and this means that my interest in collecting views and stories and then checking them for bias and practical value is keener than most.  I have a vested interest in seeking truth and balance, my belief is that most things are not as simple or black-and-white than they seem at first.

I will be writing on the trends and ideas that underlie changes in this astonishing country.  I believe that China has a great future role in the world’s development and the sharing of information plays a vital part in that future.  That said I welcome any comments or feedback to my posts.  I look forward to providing something useful and new and learning from you, the reader, in return.