I am going to start this post out with a warning: in the world of global economic intrigue and gamesmanship, the following ranks rather low on the excitement scale … but on June 22nd, China announced that it would scrap the export tax rebate it gives to China producers of 406 categories of export products.  These products include steel, non-ferrous metals, fertilizers, chemicals, plastics, rubber, and glass.  This was the first adjustment in the export tax rebate since July 2009, when it was increased as part of China’s stimulus program.

Now I know that, for most of you, the phrase “export tax rebate” doesn’t send a thrilling chill down your spine … and if it DOES, then maybe you need to get out more.  But we think that there is something deeper here that is worth exploring just a bit further.

This policy announcement is coming at an interesting time.  The communication between the U.S. and China on the global economy and the RMB valuation has had more passive-aggressive subtext than a Midwestern family Thanksgiving – “PLEASE pass the SALT, DEAR!!” – so one rather hoped that any move by China would be attempt to alleviate some of the stress … as in “Please ADJUST your RMB rate, DEAR!!”.  However, at first blush, there is not a huge material impact to the trade imbalance as the policy change is not expected to make a major dent in exports, since it affects only $11 billion in exports, or about 1% of the total.

However, we think that the importance of this policy change goes beyond any material impact.  We think that China is trying to telegraph some very specific messages to two constituencies: the international community and its own people.

First of all, the Chinese government is signaling to its own domestic manufacturers that it wants them to curb overcapacity, move up the value chain, and turn away from the export-driven model of growth.  In this new policy, the government has focused on the environmental benefits of discouraging the production and export of these 406 products, which are highly energy-intensive and polluting, thereby scoring a point with the Greens, both domestic and international.  Lower production will save energy and reduce greenhouse emissions, in line with China’s stated promise of reducing energy consumption per unit of GDP by 20% from 2005 to 2010.  Again, this move is not going to get China all the way to environmentally friendly heaven, but it’s a step in the right direction.

At the same time, this move is a response to recent global pressures on the RMB and non-tariff trade barriers, trying to get China to be an engine of global recovery, rather than continuing its export-driven model.  Europe and the US are trying to export their way to recovery, so someone’s exports have got to go down.  By partially eliminating the export rebate, in line with RMB revaluation, China can better claim that it’s pulling its weight globally.  Given that this is a partial rollback of the stimulus package, China can also claim that it’s dealing with stimulus-induced preferences for domestic industry, further reducing what some say is over-investment by the Chinese government in their own infrastructure which has led to an over-inflation of China’s GDP growth.  So that’s quieting 4 squawking birds of international conscience with one stone of administrative action … not bad at all.  The tortured metaphor of that last sentence does not give enough Kudos to China for this move … China is definitely starting to understand that, for its policy changes to have impact, symbolism – properly spun – can have more power than substance in the world of international diplomacy.

However, of the two possible audiences for this move – internal and external – we fall on the side of this being a stronger message to its own domestic producers, an encouragement to move up the value-chain and pursue domestic innovation, not just be the manufacturer for the world.  Steel is a good example.  48 of the 406 affected products are made, at least in part, from steel that, until this action, had enjoyed a 9 percent rebate.  Steel exports from China have grown 127% year-on-year, and 266% alone just this past May.  However, along with this growth have been the installation of new steel-making facilities in China … despite a general ban on adding more capacity, Chinese companies found a way to build 40 new steel plants in this past year.  This has resulted in the overproduction of low value-added steel which means that China’s steel industry profits have come almost entirely from the 9% rebate.

But this new ruling makes a fine distinction between the two types of steel products. The rebate on the commodity steel goes away but the higher value-added steel products such as cold-rolled and galvanized steel – which many US buyers are more interested in anyway – still enjoy a 13% export rebate.  So, by getting rid of only the rebates on low-valued added products, the government is sending a signal to the domestic industry: “Start moving up the value chain, and stop building so bloody much capacity.  Move away from the low-cost export model and start innovating.”

After over 20 years of concerted effort on building their economy through exports, China is going to take awhile to turn this ship around.  In other words, China is not going to becoming a domestically-driven (and particularly a consumer-driven) economy any time soon … I don’t even think the next 20 years is going to get them there.  But bit by bit, they are moving that direction … and this recent policy change is one of those bits.  And keep your eyes and ears open for future policy announcements … more and more you are going to see the double purposes behind policy changes as China navigates the dangerous waters between both the internal and external constituencies most impacted by such changes.

As we’ve been saying on this Podcast for a month or so now, China had a really good 2009.  While most of the world is thrilled to send 2009 off to the Group Home for Annoying Old Years and welcome 2010 in diapers, China is still doing victory laps for their 2009 performance, even though it was down severely from previous years.  There is a lesson to be learned here … in a room of ugly people, the average schmuck is a supermodel.  And trust me … I know how to do schmuck.

But as we all know, there is the story of what is happening in China, and then there is the truth.  Not to go all post-modern on everyone here, but the truth – if there is one Truth with a capital T – is probably somewhere in between and pundits aplenty are rushing to fill the blogosphere with their version.   For some reason, every time a talking head heaves an opinion on China into the public sphere, I have this overwhelming need to comment on it, to give the general public the beneficent view of my own brilliance and expert insight.  I know, you don’t have to tell me, I need professional help, I am fully aware of that.  I’ve tried therapy, several mood-altering substances and, as a last gasp effort, producing this Podcast, but I it hasn’t helped much.  The end-of-the-decade articles on China were killers … everywhere I looked there seemed to be an opinion popping up that absolutely REQIRED my commentary!  I consider it a mark of my immense self control and budding maturity that I was actually able to lead a somewhat normal life in the midst of all of that and did not spend all my time blogging back.  Thank you in advance for your kind words of congratulations.  I just live one day at a time.

But there is one article published way last October that I keep coming back to and, finally, cannot help but comment on.  It is by Rana Foroohar in Newsweek International is tantalizingly titled, “Everything You Know About China Is Wrong”.  The title alone compelled me to read and comment on it since, as China market strategy consultants, we go to market with what we call a “correct” view of China based on 25 years of experience so I was anxious to read it.

Ms. Foroohar elucidates several reasons why China is not the economic miracle that everyone seems to think it is.  Her opinions are not rocket science nor are they all that original … over the years there have been China-doubters aplenty who look askance at the phenomenal growth in China and wondered two things: a) is it really possible; and b) is it really sustainable??  But just because something is not original does not mean that it is not worth listening to (I give you anything recently recorded by Lady Gaga and the Jonas Brothers as proof positive of this) and I would encourage you to read her article (those of you listening to this Podcast can go to our blog for the link).  Overall, I agree with most of the statements that Ms. Foroohar makes and, in fact, I think she makes them very well; however, I would like add a couple of perspectives from the cheap-seats…

One of the myths that Ms. Foroohar attempts to deflate is “The Communists are brilliant economic managers”.  The evidence in favor of this belief is that, in 2009, China was able to maintain an 8% growth in the face of what is arguably the world’s worst economic meltdown ever.  The criticism is that this growth is driven by government investment in infrastructure and that, some day, China will have all the roads, bridges, tunnels, telecommunications networks and subways that it needs and won’t be able to make the transition to a privately-driven economy.  And it is argued that this last round of economic stimulus spending in 2009 just further deepened this problem.

This is not a new criticism and, in fact, economists, China watchers and the rabble of doomsday pundits have been making this statement since China first started their massive investment campaign in the early 90s.  For the most part, I would agree … focused investment on infrastructure is, by definition, not sustainable and, someday, China is going to have to broaden their economy to bring in other, more sustainable engines of growth.  However, I would add two caveats that would argue against being too concerned about this right now.

First of all, despite nearly 20 years of infrastructure investment, China has just scratched the surface of their total need.  China is a MASSIVE place and, while the infrastructure in the big cities of Shanghai, Beijing and Guangzhou is quite good, there is SO much more to be done in China’s Tier 2, 3, 4 and smaller cities (remember that China has over 100 cities with over a million population plus a seemingly endless countryside).

What I am saying is that the need for this spending – and the associated support it gives to the broader economy in terms of employment and supply infrastructure – is not going to end any time soon.  In fact, its probably going to continue strong for the next 20 years or more.  Yes, there are many associated problems with such infrastructure investment – the housing and real estate bubble is probably the most concerning – and China is going to have its ups and downs.  But this is not a small country we are talking about where you work hard for 10 years and everything is built.

My friends and colleagues in India only WISH that their government would have a similar commitment and authority to build infrastructure in their country … if they could, then I think India’s growth would quickly catch up to China’s.  But as it stands, there are so many internal politics in India that infrastructure projects often get stalled and never completed (there is a highway construction project in Chennai that I see when visiting clients there … and for over 5 years it has remained in the same state of incompletion.  There are people at the site and they look like they are doing something … but nothing seems to get done!).

Spending on infrastructure is not going to end any time soon … but the government can do something about the types of infrastructure they invest in.  The 2009 economic stimulus package of over $600 billion from the China government earmarked over $100 billion for what is called “social infrastructure” … hospitals, schools, etc. In the long run, the return on this type of infrastructural investment can be huge … and as I’ve addressed many times before in these Podcasts, China healthcare is in desperate need of life support itself and sustained investment here will do wonders.

Secondly, we need to understand – and even appreciate – the investment perspective that the China government takes in these projects.  Ms. Foroohar quotes a business professor who observed that, although there was a nice new highway built between two rural areas in China, there was no traffic on the road.

[let me just stop for a moment and ponder what it would be like to have a road somewhere in China without an immense amount of traffic on it … living in Shanghai where traffic is so bad we actually USE our fenders, that is a nice thought . OK … I am better now.  Thank you].

A couple of quick responses to this: is there infrastructure in China that is built without any thought to its eventual use – what in the U.S. has been called the “bridge to nowhere”?  Yes, definitely.  The number of pork-barrel projects here are directly proportional to the number of people schlepping the barrels … and we have nearly 5 times that number in China than they have in the U.S.  So yes, nosy business professors are going to be able to observe such examples of poor use of capital resources.

However, I think that the professor should relish in the fact that he can stand on that highway in complete safety.  Fast forward 10 years and I would venture to guess that this same professor would not be willing to stand in the middle of that road – there will be SO much traffic on it so as to turn him into a human speed bump.  In any environment, the population expands to fit the capacity provided and in China, this is doubly true.  Where I live in Shanghai, on the Pudong side, this was just rice fields a few years ago and now it is bucking to be a leading financial capital of the world.  There are putting up an 80-story building where just 20 years ago water buffalo grazed (giving a whole new meaning to the phrase “a bullish market”, I suppose).  The primary reason behind the real estate bubble here is that people are SO confident in their speculation that they are willing to bet large sums of money on property that will quote-unquote “some day” actually be worth more than the exorbitant price they just paid for it.  Oh, that and the fact that much of the real estate investment is being driven by people not using their own money but the government’s … but that is an issue for another Podcast.

So we should not be asking the question: “Is China’s spending on infrastructure sustainable in the long term” because it is, by definition, NOT sustainable.  Of course it isn’t.  We should, on the other hand, be asking the more difficult-to-answer question “what do you mean by ‘long term’”?  We are only 20 years into a modern business environment in China, and look how far we’ve come.  Of course, you don’t drive well by admiring the view in your rearview mirror (although that might explain some of the traffic problem here) so we need to look ahead.  My point is that, barring disasters of all types, China’s near to mid term looks pretty good and very sustainable.

Of course, there is a LOT that I do not understand about macro-economics and I am sure that I will get nasty letters from the Association of Super Smart Economists of just how wrong I am.  But to be honest, how accurate are those Super Smart Economists?  They are working off of models developed in other economies in other cultures at other times and have been woefully inaccurate in predicting even the things they supposedly understand well (ala the mortgage crisis).  The fact remains that we don’t have ANY case studies to guide us as to what might happen here in China … there has never been a country in history that is this large and has made this big of an investment in their infrastructure and government spending.  The U.S. and Japan are in the same direction, but they did theirs at very different times in history when the world was a VERY different place.  Yes, China will eventually have to pull out of this model … it cannot continue forever.  But we don’t have any good examples of a situation of this scale where this has happened.  As I have said before, in China, we are working without a script AND we are working without a net!

Twenty five years ago, when I first came to China, if someone were to show me a picture of what Shanghai would look like in 2010, I’d think they were smoking something.  NO ONE could have – or would have – predicted this.  Indeed, there were multiple doomsday preachers talking about the immanent collapse of “Red China” (I love that term, Red China … like it’s a theme color for the day!).  But here we are, still technically “Red” but, so far, no collapse.  Could it happen?  You bet.  But I assume that the only completely untrue statement is “I am 100% right” so it could also not happen.  And I am betting on the latter.

Thanks again for listening.  Remember our motto: “In China, everything is possible but nothing is easy.”  We’ll see you next time on the China Business Podcast

In our recent Podcast series, we have been talking with Bill Powell, senior writer for Time and Fortune magazines, based in Shanghai.  In the last Podcast, we got into, what I thought, was a VERY interesting discussion about the uniqueness of what is going on in China these days.  Literally, what we are seeing in China is unprecedented … never before has an economy (and a society) grown and changed so much in such a short period of time.  Understanding it, let alone predicting it, is very difficult and we are all, in a sense, working without a script.  We talked earlier about what the U.S. and other Western economies could learn from China … to wrap up our conversation, I started by asking Bill what he thought China could (and should) learn from the West …

My mother told me that its not polite to say “I told you so”, but I can’t help it.  From the start of the global economic crisis last year, we’ve been blogging and Podcasting like maniacs saying, “Yea … I know it is rough out there.  But China could be a shining light at the end of the tunnel for companies going through the rough stuff.  If the rest of your world is crumbling, now might be the time to really look at China.”

And now, no less an august body than the U.S.-China Business Council is saying just this.  In their recent survey, released on October 7^th and highlighted in this article from Industry Week, they say, and I quote, “Most U.S. companies doing business in China are profitable and many want to step up investments despite fears on the economy, protectionism and intellectual property rights.”

Yep, I told you so.

The USCBC survey is quite revealing.  51% of the 100 respondents projected that their revenues in China will grow in 2009, and 84% said their China operations remain profitable.  How many of you can say that about your U.S. operations?

A year ago, when the nasty stuff hit the fan, the one question we asked was “Where are you going to look for growth?”  We received a number of comments using words that my mother would never approve of … but all of them were along the lines of, “Are you nuts???  Growth?? Who can look for growth?  We are only interested in survival at this point!”  Yea, I get it … when you are shedding employees and operations faster than an Eskimo stripping on a Miami beach, its tough – maybe even unnatural – to ask about growth opportunities.  But that’s what separates the men from the goats, isn’t it … asking questions and using different words from what your competition is asking.  They say “tomato”, you say “kumquat”.

So I am going to go out on a limb here and repeat what I said a year ago … in 2010, companies should be looking to China for new growth opportunities.  I’m talking blue ocean, limited competition, boldly-going-where-no-person-has-gone-before stuff.  Seriously, most market sectors are still doing double-digit growth in China, more than the existing suppliers can supply.

Yes, the signs in the U.S. and Europe seem better … capital markets are improving a bit, money is starting to flow and buyers are starting to buy.  But recovery is going to be slow … slow like glacial slow … slow like the speed of mammal evolution slow.  Dollars to donuts, you are not going to be able to sustain your company waiting for your domestic markets to come back.  China could be part of your answer.

Now I know my smarmy tone is probably not appropriate … going after China is NOT easy.  We’ve never said it was … in fact, this blog and Podcast is dedicated to exploring just what a royal pain in the backside China is to succeed in.  But the difficulty of success here should not be confused with the importance of the pursuit.

Everyone is deep into planning for 2010 so you are setting priorities and budgets.  If China is not among your top priorities, then it probably should be.  Almost 90% of USCBC’s members surveyed indicated that China remains the top or among the top five priorities for their global investment plans.  Is it yours?

Now, my momma done raised me right.  I try to keep my elbows off the table when I eat, say “excuse me” when I sneeze and open doors for people when I can.  Mom also told me its not right to say “I told you so.”  So do it right this year … listen to what everyone is saying and get things in gear for China.  Get your team together Monday and ask yourself a simple question: “What are we going to do in 2010 to grow in China?”  Don’t make me have to say “I told you so” again next year.  I am already in enough hot water with Mom over missing holidays, birthdays and not writing as often as I should … and I don’t want to make it worse.

The story can be summed up in Friedman’s first paragraph: “I believe future historians may well conclude that the most important thing to happen in the last 18 months was that Red China decided to become Green China.”  While the juxtaposed color metaphors are cool, I think he might be reading too many of the government’s brochures!

Yes, China is starting in invest massive amounts of money into exploring green-tech initiatives, much of it coming from their economic stimulus plan.  However, China will have two ends of the spectrum … one VERY high-tech and “green” development and the other VERY old-school with polluting factories that will continue to dump junk into the environment for many decades to come.  China still generates 70-some percent of their energy through burning coal … I heard a statistic (but cannot support it) that China  brings on one new “clean” power plant a month (water, wind, nuclear) and yet a new coal-burning power plant still opens here EVERY WEEK.  This is the irony of China … kind of like the brand new airport built so far out of town that it is only reachable by dirt roads.

The air and water quality in China’s cities are still some of the worst in the world.  I was out in a Western city a few months ago and refused to eat any of the local seafood … I had seen the state of the fish ponds sitting right next to the chemical factories!  And just yesterday, there was a yellow haze in Shanghai that reminded me of a scene from Blade Runner.  New, high tech, green initiatives will certainly help China going forward, but there is a TON of damage already done to the environment here that is going to be difficult to help with the new magic.

Hopefully, the aggressive, growing edge of China’s green-tech developments will spur the U.S. and other Western countries into truly innovating, as did Sputnik.  China might be able to grow their leading edge, but it is going to leave the trailing edge even farther behind.

This is an excellent article by Steve Minter, Editor-In-Chief of Industry Week, as he examines some of the turnaround planning being done by companies in China. My colleague Steve Ganster, who has provided business recession recovery advice over three decades in China is interviewed for this article.

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Every market prognosticator worth his/her/its salt is in constant search-mode for “leading indicators” – data points that show us which way the markets are shifting and where trends will be moving before they actually become trends.  The easiest (and most used) are probably the ones everyone knows: GDP, consumer prices, commodity prices, exchange rates, etc.  Look on the back page of any financial magazine and you’ll find them … the problem, is that different sources will have different data, all highlighted by an asterisk that tells you why they are different.  Then mix in the challenge in China where economic data is so fraught with government intervention and interpretation so as to make it intelligible at best and downright false at worse.

These indicators are pretty important – as we’ve discussed in these pages before, everyone is looking for the “bottom” of the market and the economic windsocks and canaries in the coalmine are the only way we have of seeing this.   Everyone is looking for the upswing, particularly here in China which is expected (read: “desperately hoped”) to help lead a global recovery.

The more smarmy among the economists have tried to come up with “common sense” indicators, the best-known of which, probably, is the Economist’s Big Mac Index.  This is based on the theory of purchasing power parity (PPP) which says that exchange rates should equalize the price of similar goods between economies.  They use the Big Mac, a product available across most markets in the world, as that standard and compare the Big Mac prices when converted into US dollars at current exchange rates.  This is all well and good … but with the increasing health consciousness of many populations, it might be a good idea to get away from the Super Size Me indices.

So what else can we use?  I might have an idea …

I live in Pudong, the “new” area of Shanghai where construction cranes have been the city bird for the past 5 years and building has been going on 24-7: industrial, commercial, residential … everything has been going up in a flurry of activity.  However, starting last fall and then hitting a low point around Chinese New Year this year, things have been going oddly quiet.  In what used to be a dust-choked part of town we can now see blue sky.  What’s up with that??  Dust, dirt and noise are good – they are signs that stuff is happening!

But over the past few weeks, things seem to be changing, and that has resulted in my discovery of the perfect indicator that we are on the upswing in China – I call it the Teenage Attitude Index (or TAI). The TAI is plotted on a matrix with “Weekend Wake-Up Time” on the vertical (plotted inversely so an earlier wake up time gets a higher score) and “Crabbiness Factor” on the horizontal.  The louder the construction is around us and the earlier it starts, even on Saturday and Sunday, the earlier the kids wake up and the more angry they are that they had to wake up early.  It works really well and I can clearly plot the upswing here: the past few weekend mornings, I have observed my teenagers very carefully and have noted that they are not only waking up earlier but are in a MUCH worse mood when they do.  And I could not be happier!!  Sure, we start to hear jackhammers and cement trucks at 5 a.m. on a Saturday, but that just means that life is returning to our definition of normal.  And the grumpy look on the faces of my darling children are empirical proof of this.

The only piece I have not worked out yet is how to differentiate between the crabbiness brought on by construction noise and the crabbiness associated with simply being a teenager.  But once I figure that one out, I am going to be the Nostradamus of Asia.  Who knew that teenagers could be so helpful??

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Sheesh … can’t a guy get away for holiday without the world falling apart??  I go for 10 days of sun, sand and minimal Internet and come back to find the world upside down.  AIG needs more money (to fund bonuses? foreign banks? Liddy’s baseball card collection?) and President Obama is firing CEOs (not that many others have wanted to do the same in the past but lacked the political will and cajones).  China dope-slapping Coke in its attempted acquisition of Huiyuan is counter-slapped by Australia for Minmetals attempted investment in OZ Minerals.  An apt description from Dr. Venkman in Ghostbusters: “Cats and dogs living together!  Real wrath-of-God stuff!!”

Not that the situation would be any different if I would have been on the frontlines last week, bravely Podcasting and blogging about the world from my 5th floor Shanghai office … but I do have a bit of a Rip VanWinkle feeling about it all.  To have so much happen in the space of just over a week makes my head spin (causing the too-small brain inside my rather large cranial capacity sound like some Cinco de Mayo maraca jam session).

The suddenness of all this – and too much free time on a beach – has led me to think of three deep thoughts:

Deep Thought Number One: the age of dominance of the western multinational company (MNC) is over. Actually, I think this dominance has been over for some time but we’ve been so busy kicking the body and yelling “Look!  Its moving!” that we’ve not realized its dead.  Certainly this is true in manufacturing … that happened some time ago when we started worshiping at the alter of the god Wal-Mart to receive the deity’s blessings that came from cheap products manufactured in low-cost countries.  I am not saying we would/could/should have done anything differently, but we are where we are.

So maybe the proper way to say this is that we Westerners need to lose the illusion that we are in total control of the world.  We are not.  And the last stand where at least Americans could claim dominance – the financial sector – has completely lost its mojo (and most of its money).  The title “Bank Manager” has become the new oxymoron replacing “student-athlete” and “country-music”.

Practically speaking, this means that Western companies will now be the seller as often (or even MORE often) than they are the buyer.  For every Coke-Huiyuan situation we will find Chinese companies buying medical companies (ala Mindray), mining rights (ala Minmetals) or car companies (ala a billion rumors in the market about various GM divisions being schlepped to the Chinese ).  Certainly, there are massive financial and cultural hurdles to overcome for Chinese companies and institutions to become major buyers, but there is definitely the motivation here and there are certainly enough Western assets – distressed and otherwise – for them to pursue.

Deep Thought Number Two: China WILL become a stronger global player in several sectors. This is a natural result of the first … if there is a leadership vacuum created by the decline of Western firms, someone will step into their place.  And the Chinese seem to be the most likely to come off the bench and make the winning basket.  I see three sectors to keep our eyes on – two are no-brainers and one might be a long-shot.

The first sector where China will begin to gain global leadership is, obviously, automotive.  Already the second-largest auto market in the world, China is also the leading supplier of auto parts and components to the world.  China will begin to leverage this supply chain dominance into actually creating cars to sell into other markets.  It is already happening in southeast Asia where a number of Chinese suppliers are exporting cars.  And Chery attempted a distribution agreement for small cars with Chrysler in the U.S. before the U.S. auto world turned upside down.  Finally, China has declared that they WILL be the global leaders in electric cars and technology – in the next three years.  That is very aggressive but it seems the entire economic and political system is focused on doing this.  Look for the leading China auto companies – SAIC, FAW, Dongfang, Changan, Chery and the cheeky BYD – to flex their muscles internationally.

The second sector is medical device.  Again, China is a leading player in the supply chain of components to the global medical industry but strict regulatory requirements have kept them largely from being very strong in Western medical markets.  The Mindray acquisition of Datascope last year was their attempt to change that – Mindray is the biggest Chinese medical device company, competing against the big boys of GE, Philips, Toshiba and Siemens.  Their acquisition of Datascope, a mid-sized U.S. player in the patient monitoring device sector, was Mindray’s first entry point into the U.S. market.  Look for them and others to follow. But look particularly at China becoming an even stronger growth market for medical companies of all kinds.  China will be investing a big chunk of their economic stimulus package in their medical sector in an attempt to rapidly upgrade the penetration and quality level of medical care for their 1.3 billion population.  As they do this, there is going to be a lot of money out there to purchase medical devices, pharmaceuticals, lab equipment and even healthcare management solutions.  Any medical company of any size should be looking at China as their key growth market in the mid-term.

The third sector to keep your eyes on – and I know I am out on a limb here – is the financial sector.  What?, you say.  A centrally-controlled, socialist system with a partially convertible currency is going to become a leader in global finance??  Yes, that is exactly what I am saying.  I am not saying “tomorrow” or even “in the next 20 years”, but all you have to do is follow the money and the motivation.  China certainly has the money – both in cash and U.S. T-bills – and their motivation is repeatedly being articulated – the latest has China’s leadership saying that they hope to build Shanghai into a major financial sector by 2020 and that “the Chinese Yuan will become a new world-favored currency by then”.  Gutsy?  Sure.  Possible?  Maybe.  But are they going to work on it?  You can bet on it!

This all leads us to my Third Deep Thought:  When it comes to the future, we don’t know JACK!! I know … as the proprietor of a leading market strategy consulting company in China whose very JOB it is to predict market futures for our clients, it is counter productive to admit this.  But c’mon … consider the situation.  If, 18 months ago, you would have told anyone with half a brain and a cable TV subscription that Lehman Brothers, Bear Sterns and AIG would be toast at the start of 2009, we would have assumed you had only a quarter of a brain.  Two years ago – even in the midst of big changes already happening in the automotive market – if you would have said that the U.S. Big Three would be on the edge of global collapse and that BYD (hitherto known as a battery maker) would make the biggest splash at the Detroit Auto Show, we would have taken away the last 25% and made you ride the little bus.

The truth of the matter is that we – meaning pundits, consultants, politicians, TV news anchors, banking regulators (if there are any left) – have NO idea what is going to happen next.  Sure, we know that “down” is still the trend and that “flat” is the new “growth”, but the details of which movers and shakers will actually be the ones shaking and moving is a complete mystery.  So let’s give up trying to predict where things are going and start act like they are going to go somewhere.

This means that we – and by “we” I mean “we Westerners” – get it through our neatly coiffed (but thick) skulls that we are not going to be returning to “normal”.  This economic crisis is not just a speed bump on the journey that we’ve been on since the dawn of the industrial age … it is a fork in the road with a car-swallowing pothole in it, at the bottom of which is a pack of very hungry lions who have been subsisting only on lettuce and Fruit Roll-ups.  OK … that metaphor needs a bit more work, but the bottom line is that EVERYTHING has changed!  The products, pricing, distribution, supply chain, competitors and even regulatory environments of your business are changing radically.  New players – many of them Chinese – are not just playing in the shallow end of the business pool; they are swimming in the deep end and, frankly, many of them look pretty good.

What has not changed is the advice for Western companies regarding China – we have been saying this for a LONG time and, in fact, we can maybe put a sharper point on that advice which is: your company’s future WILL be involved somehow with China so find out what it is now and start working on it.  In the midst of the global economic meltdown, China is still one of the best places for pure growth in most sectors.  You are probably not going to find growth in your home markets in the U.S. or Europe so why keep banging your head against that wall?  Net-net: if China is not at the top of your list of “Ways to save your corporate ass and position yourself for the future”, then you are missing the boat.  That is a fact that I feel 100% confident in predicting.

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There has been a lot of press, not to mention moaning and groaning, about stimulus packages in the last few months. Many countries have put forth their genius to turn their economies around…but we haven’t seen much fruit yet to be sure, and their remains a high dose of skepticism out there on virtually everybodies stimulus approach. This skeptical view even exists with China, the global champion in actually getting things done. As usual, there is a lot of noise in the media about anything to do with China and the ever present political filters that tend to bias realities. In this podcast, I will try to cut through this static and identify what we think is really happening with China’s stimulus plan and how western companies can benefit. I’ll cover the current status of the plan, what forms the various stimuli are taking, some key themes that underly the programs and the industry sectors that will benefit most. In this horrible economic environment there are few places one can go for revenue growth. China is one of those places… so companies with the intent to find growth despite the current pain they are experiencing in their home markets, will do well to take a hard look at what is happening in China.

So let’s set the context a bit before getting into specifics on the stimulus plan. It should be clear to us by now that when the Chinese government is determined to get something done, it usually happens… and it happens fast, and often in a big way as we saw with the Olympics last year. Go to a rural township one year and it’s a patchwork of dirt roads and asphalt. Go there the next year, and not only are all the roads paved, but they are lined by quaint looking trees of all the same breed, shape, and height. Ask around, and a peasant points into the distance and says that the government “uprooted all those trees from that mountain over there”.

The Chinese government has, to date, earmarked (can I use that word?) some US$ 584 billion to stimulate things in the economy. By our US standards of throwing trillions at a problem in the hopes of overwhelming it, this figure may seem a bit paltry. But keep in mind that at 10 to 20 times the wages of those peasant tree-movers, we’re getting a lot less investment bang for our stimulus buck here. Further, the actual usefulness of the monies spent almost embarrases our US program (most pork bellies in China are served with a nice Maotai). There is some opaqueness to the source of these funds (about 25% is slated to come from the central government and the balance from provincial and local government sources). Yet China’s track record when it comes to stimulus spending is pretty stellar so we have confidence this level of resource will indeed find its way in to the market…eventually.

Best estimates say that about $57 billion (or one-tenth of the total package) has already been spent as of the end of 2008. Of this, about $39 billion has been spent on rural infrastructure, roads, railroads, and housing construction. Construction has already started on a $13 billion gas pipeline from Xinjiang to Shanghai, and there are plans to start building at least four nuclear power plants this year. As a result of these and other mega-projects, Yangtze River cargo throughput of steel, coal, and cement ticked up in January after suffering declines since last August. A sign of the stimulus at work!

I was in a meeting with China’s largest grocery chain a couple weeks ago and they were describing their brand new 1.3 mm sq ft., state of the art distribution center being developed…with monies from the stimulus. Our stimulus activities in the US seem like taking a couple advil to ease the pain of a heel spur versus China’s shot of cortisone right into the ­­­affected area.

In these types of programs, we see the Chinese government taking more of a long-term, strategic view of the investment. The goal is not only to address the short-term pain, but to build the country’s overall health and competitiveness. In this regard, it is interesting to note some of the main themes of the stimulus package…

1. Upgrading technology through forced obsolescence and replacement of outdated, energy intensive and polluting processes & equipment
2. Upgrading/expanding capacities e.g. an astonishing $90 billion has been budgeted to more than double China’s rail network over the next decade, adding 25,000km of track.
3. Providing rural development/support, as in offering coupons to get discounts on purchasing durable goods
4. Providing investment and incentives for innovation and expansion of R&D
5. Implementing industry consolidation
6. Spurring export promotion and competitiveness via putting back some of the VAT tax refunds
7. Expanding energy sources including nuclear, coal and renewable energy

We also see the government using a creative mix of methods to stimulate the market using both direct and indirect tactics…it’s not all about spending cash.

1. Tax rebates/cuts
2. Direct investment
3. Policies e.g. consolidation, financing terms
4. Technology funds
5. Direct subsidies

Ten industries have been designated as direct stimulus beneficiaries: automobiles, steel, textiles, shipbuilding, petrochemicals, light industry, electronics, nonferrous metals, equipment manufacturing, and logistics. Not many areas will be unaffected. The government will employ a mix of the methods I just mentioned to bring help to these sectors. Some will benefit from consumption subsidies, e.g. 13% off for peasants to buy mobile phones, computers, and home appliances. Others, such as textiles and light industry, will get bigger export tax rebates. The auto industry will get some help through tax reduction, e.g. going from a 10% to 5% purchase tax to buy a car.

Almost all of the industries will benefit from government commitments to invest in innovation and new technology, with multi-billion dollar funds already announced for the auto and steel industries. The government is also taking industrial policy one step further, guiding consolidation in the fragmented auto and logistics sectors, and getting rid of excess capacity in steel, metals, and equipment manufacturing. Industrial policy is not always spending per se (and it is important to keep in mind that the Chinese term for “stimulus,” zhenxing jihua or “rejuvenation plan,” does not necessarily imply spending), but China is clearly thinking of the global crisis as an opportunity to enhance its industrial competitiveness.

While the ambition of government planners has never been in doubt, there is always some concern for the reality of things in China given that the government always retains a level of opaqueness in its announced programs. So we do need to take some of these specifics with a grain of salt. There certainly will be some, how shall we say “leakage” as the money flows into the system (or the pockets of some politicians). It’s easy to suspect that some big-ticket projects and industrial policies are simply “piggy-backing” on the stimulus to give their proponents bureaucratic momentum, thus exaggerating the headline figure of $586 billion. My litmus test for the reality of these types of things in China is simply to look out my apartment window to see if I can see tangible evidence of activity. I recall during China’s boom periods in the 1990s and early 2000s when many economists doubted the reality of China’s double digit GDP growth. Yet the fact that 50% of the world’s construction cranes were operating in China at the time presented a pretty compelling case for the reality of China’s growth.

So, bottom line? China’s stimulus package is real and its impact will not only spur more economic growth in China’s domestic market but will take China to the next level of global competitiveness as we have seen happen before. The plan is not without its faults and false advertising but don’t doubt its real impact on the economy. Foreign companies, with smart and targeted growth initiatives, can take advantage of this stimulus package to obtain some added growth. You need to be proactive and aggressive to exploit these opportunities. They won’t just fall in your lap!

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