Chinese Society

If This is Chinese Corruption, Give Me More!

1 Comment / November 15, 2012

All governments favor local businesses. Some do it better than others. China is among the best. The system of government support in China is more extensive, more fair and less prone to corruption than elsewhere. Surprised? Many will be, since they operate on the false, though comforting,  assumption that everything Chinese officials do is the result of bribe-taking.

The thing about corruption is, most of it, everywhere, is hidden from view. There is no real empirical basis to assess which countries have the highest corruption. Instead, everyone tends to fall back on the “Corruption Perceptions Index”  reports generated by a group called Transparency International. It does what it can to measure the unmeasursable. Its results get skewed by relying rather heavily on Western businessmen’s own perceptions about where bribery is most rampant. For many of these people, China fits the Western stereotype of a country whose officialdom seems rotten from top to bottom.

The reality is rather different. Look, I’m not saying China doesn’t have a corruption problem. It manifestly does. The country’s own leadership is frequently heard denouncing the problem of corrupt officialdom. Indeed, China’s outgoing Communist Party boss, Hu Jintao, warned this week that if not tackled, official corruption would  “cause the collapse of the party and the fall of the state.”

My point here is to discuss the productive, above-board and even-handed ways government in China, at every level, provides useful and valuable support to companies. Here, the comparison with the US is very stark indeed. Government favors in the US are mainly, and explicitly, sold to the highest bidder. It’s what drives much of the billions of dollars “invested” every year by companies, unions, lobbyists and individuals in political campaigns. You help a politician win, and he helps you then get a tax-break, a loophole, a sweetheart government contract, a loan guarantee, a no-bid contract, a regulatory exemption, an R&D grant, a zoning change.

In the US, the system of favors-for-money is so widespread, so deeply woven in the grain of the political system, that Americans don’t even bother to talk about it much. It’s as American as apple pie.

Let’s look at China. Buying off politicians is less visible, and outcomes are different, than in the US. China’s tax code is not the unwieldy monster it is in the US. It isn’t the product, as America’s is, of an anybody-want-to-buy-a-taxbreak system. In the US, General Electric can get away with paying no income tax despite billions in profits because it’s very good at working the system and buying the favors required to create tailor-made tax loopholes. In China, I know of no instance where a big and profitable company, including some very powerful SOEs,  pays no tax.

Big companies, especially SOEs, do get many special favors. One example:  the government tends to be very relaxed in its role as controlling shareholder. It seldom demands an SOE turn over a large percentage of its after-profits in the form of dividends. The Chinese system generally dings companies once, through profit tax, rather than twice.

Where China’s system of political favors works better than elsewhere is in spreading the perks far more widely and equitably. So, both state-owned giants and small entrepreneurial companies can both partake.  In the US, Europe or Japan, the system of political favors is “pay to play”. In China, it’s more a matter of maintaining a modest level of employment (probably above about 50 workers) and paying at least some of the taxes you nominally owe. Do that and the government will make available a wide assortment of grants and benefits, from land at low concessionary prices,  to investment credits and tax holidays to free infrastructure upgrades.

Again, what is most notable, and commendable, about the system of political favors in China is how much more inclusive it is. You don’t need to pay off a local official, or put his kid through college in the US. That sort of stuff may happen, and may for all I know bring even larger benefits. But, a payoff is not a prerequisite for a government favor or handout. In fact, the most valuable forms of government support I’ve heard of go to companies that successfully IPO. Nothing else. They don’t need to take government contracts or employ the mayor’s nephew. Companies are rewarded by the government for going public — which, by the way, given high IPO multiples in China,  is enough of a reward in itself. One reason companies get rewarded for going public is because it also is a big boost to local officials’ careers. In today’s China, a key metric used to evaluate local government officials’ job performance is how many local companies have IPO’d.

These newly-public companies are often, if not always, sold a piece of land to build a new headquarters on. The price of that land will almost certainly be sold to the newly cash-rich IPO company for a fraction of its market value.  I’ve also seen cases where a local government gives a plot of land, at a very low price, to a local company that successfully raises PE.

A case of rich getting richer? Perhaps. But, note, this valuable land is not sold to the guy offering the valise filled with untraceable $100 bills. It is a reward for achievement, not a backhander. I prefer this kind of businessman-to-politician transaction to what routinely goes in the US, or UK, where political parties, in return for donations,  sold knighthoods and other titles.

But, the land-for-IPO deals are a very small part of a very large whole, making up the totality of government favors and support available to businesses in China. The government in China has far more power and far more wealth at its disposal than anywhere else I’ve lived. In other words, it has complete discretion, as well as more prizes to dole out. The remarkable thing is how evenly they do try to spread their help around.

In the US, a small businessman is told by the newly-reelected President he is a “millionaire and billionaire”, and should cough up half his income in taxes, with little special in return. The same scale businessman in China pays less punitive rates and is rewarded by government with favors that help his business grow, and his profit margins increase. If this is corruption, give me more!

 

 

China’s Soda Wars

2 Comments / October 9, 2012

(New Jia Duo Bao can on left, with the new SOE-owned Wang Lao Ji can on right)

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Imagine this scenario. Coca-Cola is sued for bribery and trademark infringement. It loses in arbitration and beginning the next day it is banned from selling soda under its iconic brand across the US. It immediately switches to a new name, keeping the original packaging design and colors. Meantime, the victor in the lawsuit starts selling a soda under the name Coca-Cola using the same script lettering, same can design as the original, and tasting pretty much exactly like Coke.

Sounds far-fetched, doesn’t it? But, this is precisely what’s going on now in China.  After a arbitration hearing filled with lurid tales of bribery and corruption, the country’s most popular and most famous soft drink changed hands overnight. The brand is called Wang Lao Ji, (王老吉). Everyone in China is familiar with it. It’s a soft drink made from Chinese medical herbs. It outsells Coke by a significant margin in China. Like Coca-Cola, Wang Lao Ji’s recipe was first dreamed up by a pharmacist during the 19th century, and the exact formula remains a secret. In 1949, the Chinese government nationalized the private pharmacy that owned the Wang Lao Ji recipe.

Twelve years ago, a Hong Kong company called Hong Dao Group licensed the Wang Lao Ji brand name from a state-owned medical products company based in Guangzhou. Hong Dao is owned by the descendants of Wang Zebang, the original inventor of Wang Lao Ji back in 1828.  Hong Dao invested heavily to create China’s first home-grown soft drink megabrand, borrowing many of the same techniques that Coca-Cola pioneered, including saturation advertising and efficient nationwide distribution.

Last year, Hong Dao sold about three billion (yes, billion) cans of its Wang Lao Ji. The price, at around Rmb 4 (US 75 cents) per can,  is higher by about 40% than the price Coke charges in China. At that price, gross margins must be about the highest of any legal product sold in China, probably +80%.

Since May, when it lost the arbitration case, Hong Dao has been forbidden to sell Wang Lao Ji in China under that name. So, overnight, the company switched to a new name, Jia Duo Bao (加多宝）but kept the original colors and packaging intact. Just as quickly, the Guangzhou SOE, called Guangzhou Wanglaoji Pharmaceutical Co., Ltd. (广州王老吉药业有限公司), a subsidiary of the state-owned Guangzhou Pharmaceutical Holdings Limited (广州医药集团有限公司), began selling its own version of Wang Lao Ji in a can almost identical to the one used up to then by Hong Dao.

So now there are two drinks, with two different brand names, owned by two different companies, with similar if not identical taste, being sold in almost identical cans. The famed Coke-Pepsi rivalry in the US seems like a quaint antique by comparison.

Who benefits most? At the moment, it’s the ad agencies and television stations. Both companies are now pouring in tens of millions of dollars into tv advertising to influence Chinese customers. The ads ran during almost every prime-time commercial break during coverage of the Olympics. The ads are hard to tell apart, with lots of smiling and zesty young people partying and toasting one another with red cans. Hong Dao’s ads hint that the new drink is same as its old Wang Lao Ji, but without actually mentioning that name.

During the arbitration, detailed were revealed about the way Hong Dao originally secured the license in 2000 to the Wang Lao Ji name. It turns out a manager at Guangzhou Pharmaceutical Holdings agreed to take a bribe of about $500,000 in return for giving Hong Dao a sweetheart deal. Hong Dao paid less than $1 million a year for the rights to use the Wang Lao Ji brand name in China, even as annual sales of Hong Dao’s product reached Rmb 16 billion, ($2.5 billion.)

The manager who took the bribes was given a long prison term for misappropriating state property.Perhaps anticipating it might lose the arbitration case, Hong Dao began last year putting the name Jia Duo Bao, in small letters, on its Wang Lao Ji cans.  When the arbitration decision was announced, both companies reacted with breathtaking speed and efficiency. Hong Dao pulled all its Wang Lao Ji cans and almost immediately had its new Jia Duo Bao aluminum cans in stores. The SOE too clearly had everything geared up, awaiting the court decision. Its version of Wang Lao Ji was quickly on shelves across China. The SOE says the red can’s sales in July grew ten-fold compared to the previous month.

At this point, neither company is competing on price. Nor is there any sign that the overall market for this drink is growing much. So, the likely effect will be to split the 2011 Rmb16 billion of annual sales revenues by around 50-50. Guangzhou Pharmaceutical Holdings’ stock price has shot up, anticipating a flood of profits from selling its Wang Lao Ji in the familiar red cans.  Guangzhou Pharmaceutical Holdings surrendered the tiny annual licensing fee from Hong Dao, and now own outright what is arguably among China’s ten most famous brands.

Watching from the sidelines, I remain somewhat amazed that the two companies did not reach some kind of settlement rather than going through the arbitration process. I find Chinese generally to be very practical in business, and loathe to settle disputes in court. Given Hong Dao’s revenues and likely profits from selling Wang Lao Ji, it seems it could have put much more money on the table and persuaded Guangzhou Pharmaceutical Holdings to continue to license the brand. Switching to Jia Duo Bao has imposed heavy marketing and re-branding costs at a time when its previous monopoly market share is under serious attack.

Not that long ago, of course, China was mainly a market for all kinds of knockoff products — or to use the Chinese phrase, “shanzhai” 山寨. There was little interest in or defense of trademarks and copyright. Go back 30 years to when I first came to China, and there were few, if any, brands at all. That has all changed very markedly, particularly within the last two years.

China’s consumer market, within a decade, will likely overtake the US to become the world’s largest. With consumers shifting en masse to buying brand-name products, all brands active in China, both domestic and global, across just about every product category, are scrambling for every nano-unit of market share.

In the case of Wang Lao Ji and Jia Duo Bao, never in such a short time has such a large consumer market, the one for Chinese soft drinks, been so completely ruptured and so completely remade.

 

 

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Reflections on a Sunday of Protests in China

1 Comment / September 16, 2012

“To reap the whirlwind”. It’s an ancient English saying, taken originally from the Bible. It means that actions in the past can end up having very large, unexpected consequences.

This phrase is very much on my mind today, as I listen to two unfamiliar sounds from outside my window in Shenzhen: one is of helicopters circling close overhead. The other is thousands of voices shouting angry slogans in unison. In Shenzhen today, as in cities across China, there are large demonstrations being staged to protest Japanese claims to some offshore islands nearest to Taiwan known, in Chinese, as Diaoyudao, and in Japanese as Senkaku.

I happen to live near both one of Shenzhen’s largest shopping malls, as well as its main street, known as Shennan Avenue. Demonstrators are parading down this street, and then stopping in front of the mall to wave Chinese flags and scream “Smash Japanese imperialism”, and, somewhat more incongruously, the soccer chant, “Let’s Go China” (”中国加油“） .

The shopping mall is shut today, for a second straight day, with a phalanx of Chinese police in riot gear standing between it and the demonstrators. The main tenant inside the mall is Jusco, the Japanese supermarket and department store. The mall also houses local outlets of high-end global brands like Louis Vuitton, Cartier and Ralph Lauren. A lost weekend like this is the last thing these big luxury brands need, of course, as their sales in China are already weakening because of slowing economic growth.

I’m no expert in maritime law. Equally, I’m not familiar with all the facts, claims and counterclaims about these islands. It seems rather self-evident, when looking at the map, that the islands should belong indisputably to China. But, at the moment, they are mainly a source of significant national irritation in China. Demonstrations here are rare, and always involve some degree of government approval. Tempers are high today, but not uniformly so. Mixed in with angry young men of all ages are lots of families with kids, waving small Chinese flags, taking photos as well as taking obvious pride in their Chinese identity. That’s all to the good.

And yet, I’m still more than a little uneasy. I probably have a higher-than-average sensitivity to the character and tone of Chinese street protests. I was in Beijing during the Tiananmen Incident in June 1989. All these years later, the two filaments embedded in memory are the sound of a massive angry crowd chanting in Chinese, and how quickly, explosively, unpredictably an orderly, even good-natured, protest can turn into a violent and uncontrollable mob.

The term “collective wisdom” is one I often struggle with. In my experience, the size of a crowd is often inversely correlated with the reasonableness of its behavior.  This is as true in the US or Europe as it is in China. Less than a year after witnessing the events in Tiananmen, my neighborhood in London was engulfed in what was called the Poll-Tax Riots, as tens of thousands of people took to the streets to protest an unpopular new tax. It turned into an anarchic frenzy of looting and hooliganism, as rioters set fire to restaurants and cars, and beat unarmed British police. Excitement and incitement are close cousins.

Anti-Japanese feelings run deep in China. There is no easier way to rouse a rabble here. On any given night, at least one of the country’s main television broadcasters will show during prime time a historical drama about the Japanese invasion of China, often featuring quite graphic levels of violence.  For an American, it would be something like one of the three networks broadcasting every night, every week of every year a series about the cruel Japanese mistreatment of Allied POWs during the Bataan Death March. Anti-Japanese entertainment sells in China. This year’s big budget Chinese movie, the Zhang Yimou directed The Flower of War （金陵十三钗）, was set against the backdrop of the 1937 Rape of Nanjing, and included the most horrifyingly violent and realistic images of barbarism and cruelty I’ve ever seen in a film.

Chinese lack no justification for their anti-Japanese sentiments. And yet, as this nation continues its remarkable rise, the dark grievances of the past must fade in the light of China’s current achievement and progress.  I find powerful logic in the words of a Chinese patriot who died 99 years ago, Tang Guo’an (唐国安), the first president of Tsinghua University. During the height of the deplorable Western occupation of China, Tang wrote  “were the positions reversed, China might accord even worse treatment to foreign nations. It behooves us, then, not to entertain unworthy thoughts of hatred and resentment, which will be of no avail.”

 

One Star Fits All

Leave a Comment / August 20, 2012

China First Capital blog post

Imagine a world of where every product had a single celebrity endorser. The same star would advertise on behalf of car companies, detergent, liquor, travel. Sound implausible? Welcome to the world of Chinese celebrity product endorsement, where kungfu star Jackie Chan is such a fixture of product advertising, both commercials and billboards, that no one knows for certain how many different brands he advertises.

With the help of a friend, I recently compiled a list of 16 companies Jackie Chan now shills for. There are certainly others. The list includes some brands familiar to Western audiences, like Mitsubishi Motors and Canon EOS cameras. But, most of the products are ones targeting China’s domestic market. These include a dumpling company, an air-conditioner manufacturer, an anti-baldness shampoo, green tea bags, and a laundry detergent. During the broadcast of the 2012 London Olympics, Jackie Chan-fronted commercials got far more tv time in China than Michael Phelps or any Chinese medal winner .

In the US and Europe, the generally held view is that a celebrity should endorse only one product.  Endorsement contracts usually specify this. Once a brand pays out a lot of money to get a celebrity, they don’t want that investment squandered, in part, by the same celebrity pitching for another product, even an unrelated one.

So, Robert DeNiro has appeared in American Express advertising, and nowhere else. Jennifer Aniston pitches L’Oreal shampoo, and that’s it. For awhile, golfer Tiger Woods was the one notable exception to this rule of promotional monogamy, promoting several different products at once. His marital philandering brought an end to his endorsement philandering. Every big brand but Nike has dropped him.

But, Jackie Chan in China is an advertising law unto himself. He is, without question, the most visible man in China, a wall-to-wall presence in people’s lives. The only face Chinese seen more often is Mao Zedong, whose portrait is on every banknote circulated in the country.

Simply understood, in today’s consumer market in China, paper with Mao’s face buys products with Jacky Chan’s on it.

Unlike Mao, Jacky Chan’s popularity and ubiquity in China are both a little beyond the scope of my comprehension. Start with the fact Jacky Chan is from Hong Kong, not the Chinese mainland, and his clunky Mandarin betrays that fact. Kungfu movies aren’t particularly popular in today’s China. At 58, he’s hardly a matinee idol. Most of his film work these days is in English, like the recent remake of “The Karate Kid” and “Kungfu Panda”.

China has plenty of home-grown stars. Two of them, the actresses Zhang Ziyi and Gong Li, also do a lot of product endorsements. These two share a key attribute that makes Jackie Chan valuable as a pitchman: they’ve achieved fame outside China.

These three are in a class by themselves among celebrity endorsers in China, precisely because they are the only three with real name recognition outside the country. If you want to be a truly big star in China, become even a minor one in the US.

Most of the products endorsed by Jackie Chan are sold only in China. Some, like Cree air-conditioners, among the leading brands. Others, like Fenhuang Cola, are also-rans. Nothing, though, seems to dent his value as a pitcher of products to China’s masses.

All celebrity endorsements are a paid attempt at rub-off glamour. With Jackie Chan, no matter how often that glamour gets rubbed, it never seems to dull.

 


Stir-Fried Rat Anyone?

1 Comment / August 8, 2012

Rat painting from China First Capital blog post

I was still drowsy from sleep early one morning when I heard a rustle and saw a brown flash dart across my kitchen counter. A rat. For sure. I then found some telltale signs in one of my cupboards – a plastic bag torn open and peanut skins littered all around.

My immediate thought was, “If only Chinese ate rats, there’d be fewer of them”. I’d always heard rats were one of the few animals that Chinese would not consider a meal-in-waiting.

Turns out, I was wrong about that, as this article I dug up from China Daily points out: Click here to read.

A lot of insight and wisdom, as well as the occasional bit of crackpot thinking, is contained in Chinese “chengyu”（成语）, the often-ancient sayings still frequently used in daily speech. It’s no surprise that one such chengyu is used to promote the special virtues of eating rat. It avers “one rat is as nutritious as three chickens.”

That there’s zero empirical basis for this claim is clearly no impediment to its use.  A more considered chengyu would be “eat rat and catch all kinds of nasty diseases for which there is no known cure”.

The Cantonese are widely known as the most adventurous eaters in China. There are multiple chengyu about this as well, mainly variations on the theme that Cantonese will eat anything with four legs except a table, and anything that flies except a helicopter.

Rat meat is obviously an acquired taste in China, and not a common source of protein like, for example, dog meat. If it were more prized on the table, there’d be less chance of  encountering one in my kitchen cabinet.

Equally, though, there’d be more seriously ill Chinese. On balance, I’d rather have them thrive as domestic pests, than become a toxic part of the food chain.

 

 

SOEs That Are SOL – China’s Forgotten and Unprivileged State-Owned Enterprises

3 Comments / December 15, 2013

Perhaps the most commonly-heard criticism these days of the Chinese government’s economic policy is that secret policies favoring State-Owned Enterprises (so-called “SOEs”) are becoming more numerous, heavy-handed and harmful to the prospects of private business in China. This criticism, like others of China,  gains strength and credence because it is basically unfalsifiable. Since the policies are secret and the impact hidden from direct view, the only evidence offered is the continued growth and profits of SOE giants like China Mobile, ICBC, Sinopec and others.

While it’s undeniable that SOEs do enjoy a lot of advantages private companies can only dream of, often including easier access to bank loans and markets rigged to prevent free competition, I’m dubious that a real shift really is taking place, and that the Chinese government is wholesale turning its back on private business in order to make life easier for SOEs.

Not all SOEs are living a life of wine and roses. For them, government support is limited, haphazard, often counterproductive. There are hundreds of such SOEs in China. They aren’t the giant companies many foreigners have heard of. These SOEs are surviving, but not really prospering, with clapped-out equipment, low profits, bloated workforces and balance sheets larded with debt. It’s by no means clear that having a government owner is more of a benefit than a liability.

These SOEs have no real pressure to optimize profits and increase efficiency.  Their government owners, to the extent they even notice these smaller industrial SOEs,  are mainly concerned that they should continue to provide jobs, hand over a bit of money each year in taxes and dividends, and continue to increase output. In many ways, for all the epochal changes over the last 30 years in China, many SOEs are still run much as they were during the days of complete central planning:  growing bigger is still more important than growing more profitable, innovative, dynamic.

Thirty years ago, all of Chinese industry was state-owned and most urban Chinese were employed by the state. Then came the private sector reforms and liberalization under Deng Xiaoping, the rise of private business (which officially now contribute more than 70% of China’s gdp) and the bankruptcy of thousands of large SOEs, when many of the largest loss-making SOEs were forced to close. This process of culling the loss-making SOEs is often called “淘汰” (“taotai”) in Chinese, a term I quite like. It literally means to “wash clean” or “wipe out”.

But, many thousands of smaller, barely-profitable SOEs survived “taotai”. They are the ones now often living in a state more akin to Dickensian squalor than the plush recipients of government favor. Visit, as I did recently,  one of the “un-taotai’ed”  SOEs, and you will soon be disabused of the idea that all SOEs are prospering and that the Chinese government is running an economy to benefit SOEs at the expense of private business.

The SOE I visited is in Shaanxi province, about an hour’s drive from the capital, Xi’an. The factory was established in 1966, at the start of the Cultural Revolution, by a team of thousands of workers forcibly relocated from Tianjin. It manufactures certain special types of fiberglass, including some used by China’s military and space program. The SOE still produces many of the same products, on 45 year-old equipment, in a sprawling and broken-down facility the likes of which I’d never seen before in China. Most of the buildings are dilapidated, the roads inside potholed. Polluted waste water belches from pipes into overflowing holding pens.

This company, in one sense, is lucky. It has no competitors inside China, and only two elsewhere, Soviet-era factories in Byelorussia and Latvia. Saddled with unnecesarily large payroll and other ancillary costs not related to producing fiberglass, profit margins are low. But, the company earns money most years, including about $1 million in profits in 2011.

The problem, though, is that the company can’t get the capital to modernize, expand or rationalize its workforce of almost 2,500. It’s still responsible for the running costs of a local hospital, school and kindergarten. When the company’s boss goes to the government for help, he’s mainly told to fend for himself. The company is too small to get any attention from its government owners. So, it floats along in a kind of sad limbo.

With money and profit-seeking owners, the company could probably grow into a quite successful industrial business. The market for its products is actually growing. If they could let go excess payroll and obligations, margins would likely rise above 15%, generating sufficient surplus to finance the large expansion plans and upgrade the company’s boss has been trying, unsuccessfully, to implement for six years. The government says it has no cash to inject. State-owned banks, for all their supposed leniency towards SOEs, won’t increase lending. Instead, the government is urging the factory boss to find a private investor, to put together some kind of privatization plan.

But, in this case and many like it, whenever the Chinese government won’t invest, few if any sane private investors will. Any new investor would have to fund the cost of layoffs of up to 1,800 people. Most are entitled to one month severance for every month of employment.  Average salary is around $500 a month.

The new investor would also, according to Chinese law, probably need to buy its shares from the provincial arm of SASAC at a price tied to the company’s net assets, not its rather dismal operating performance. The entire business may be worth only $10 million. But, using the net asset formula, which includes a big chunk of valuable land, the price almost triples. After all this money goes out the door, the new investor would need to pump another $12mn-$15 mn into the company to finance improvements and expansion.

For any investor seeking to buy control of the company, the likely rate of return after all these outlays, even under the most optimistic scenarios, would be under 10% a year.  That’s a deal that few investors would consider. Along with the need to shell out all the money, a new owner would also acquire lots of contingent liabilities of unpredictable size and severity, including the cost of an environmental clean-up, repairs to company-owned housing where most of the current 2,300 workers, as well as retirees, live.

After spending the day with him, I sympathize with the company boss’s plight. He wants to run an efficient operation, turn it into a leading producer of certain high-technology fiberglass materials, and maybe earn his way into owning a small piece of the company. But, the current mix of policies in China will make that hard, if not impossible, to achieve.

While big SOEs do enjoy a lot of political clout, with sparkling new headquarters, and a low cost of capital that other companies envy, these smaller SOEs inhabit an altogether different and inhospitable world. Government ownership is far more of a hindrance than a help. And yet, they have no real way to free themselves.  These SOEs are, as Americans would say, SOL.

 

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Funny, You Don’t Look American

3 Comments / May 7, 2012

If I had one minute of national air time in China and could provide a single piece of information to correct a deep cultural misunderstanding, here’s what I would say, “You like to try, but it’s really hard, maybe impossible, to guess a white person’s nationality.”

Just about every Chinese I meet asks me where I’m from. My usual response is “Where do you think?”. What then follows, almost invariably, is “You look like you are from…” following by the name of various countries inhabited by large numbers of white people. Canada, France, Australia, Spain, Russia, Switzerland, Italy. I’ve heard them all.

There’s usually a note of certainty and keen deductive reasoning about it, for example, “people as tall as you are come from France, so you must be French”, or “people in America have big noses, and you do, so you are American, right?”, or “you are so friendly, you are English”, or “Canadians have blue eyes, so you should be Canadian”.

There is universal disbelief when I explain that white people pretty much all look the same, and that in most cases, I can’t tell by looking at Caucasians where they are from. The small clues I might use – differences in clothing, accent, hairstyles – are not perceived or understood by Chinese. They just look at the skin color and then form a conclusion.

About one-third of the time, someone guesses right. When I ask them why they think I’m American, I hear all kinds of things, some flattering, some not. Equally, when I correct a wrong guess, I’m then often lectured, in a friendly way, why I couldn’t possibly be American, because American men are all lighter-skinned than me, or have mustaches, or are balding. And so on.

I always enjoy these little exchanges. As far as I can tell, my Chinese interlocutors do as well. If I have the time, I’ll explain that white Americans are really deracinated Europeans, whose ancestors came from England, Germany, Ireland, Italy, Eastern Europe. We still look pretty much the same as people still living in those places.

This usually is news to Chinese. I suggest to them that just as lots, though not all,  Japanese and Koreans can pass for Chinese, and that large numbers of Thai, Indonesian and Filipino citizens have Chinese ancestry, so many white people look like they could come from any number of different countries.

From what I can tell,  many Chinese think there is a distinct American “race”, with unique appearance and physique. Sometimes I fit that “genotype” for them. Sometimes not.  Chinese are used to hearing over and over how their own country is made up of 55 different ethnic minorities, many of whom look rather similar to the Han people who make up 91%.5 of the country’s 1.3 billion peope.  Quite a few, therefore, surmise countries in Europe and North America are populated by unique “races” , all somewhat similar, but each with its own unique ethnic identity. Sometimes costumes as well.

The irony is that when pressed, most Chinese will admit that to them, all white people look pretty much the same. They are happy to guess a white person’s nationality, despite the fact that to them whites all look more or less alike. From what I can tell, Chinese don’t “see” a white face the way white people do. They don’t apprehend the big differences among whites in hair, eye and skin color.

If some of these more subtle differences don’t make of an impression, overall Chinese have gotten far more familiar seeing white faces, mainly on TV, but also in major cities like Shanghai and Beijing. Compare this to the situation 200 years ago when Europeans first began making their presence known, often forcefully, to the Chinese. Then, Chinese described foreigners mainly as peope in garish costumes, with long red beards, and an overall appearance not unlike either monkeys or the devil. (The porcelain plate displayed above is from that time, the Qing Dynasty, showing a Chinese official receiving a European envoy.)

Truth to tell, I don’t much like being mistaken for a Russian, the most common guess. But, I’m always greeted warmly and with genuine curiosity and goodwill. That’s something those earlier visitors of European ancestry rarely, if ever, experienced.

 

 

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A Sense of Place – The Key Role of Laojia in Forging Chinese Identity

4 Comments / February 7, 2012

Ask Chinese where the country’s leader Hu Jintao comes from and you will be told “Anhui Province”. Simple. Except it isn’t. In Jiangsu province recently, I was told by several locals that Hu was raised and schooled in Taizhou, a small city in the northeastern corner of their province. Disinformation meant to confound a foreigner? Apparently not.

In this case, as well as in China more generally, both can be true simultaneously true, that a person is said to come from one place, although he was actually born and raised in another. The reason for this seeming conundrum is the central importance Chinese themselves place on the concept of 老家，(“laojia”), literally one’s “old home”. It is, after asking someone’s name, the most common as well as most pertinent question you hear people ask one another when first introduced, “where in your laojia?” .

Chinese ask because nothing else is meant to be as telling, as shorthand, in determining the character, interests, personal habits, even taste in food of a person you’ve just met. Your laojia is Henan? It’s a place of con artists and simple poor peasants. Hubei? The smartest Chinese come from here.  Guangdong? Not keen on education but good at making money. Shandong? Strongly influenced by the values of the province’s native son, Confucius. And so on.

Laojia matters because Chinese are convinced it does. Living here, I’ve adopted the habit of asking a person’s laojia and have come to see it as providing some clues to a person’s character – if nothing else, it can often indicate a person’s tolerance for spicy food, preference for noodles or rice, yen for hard liquor.

In Hu Jintao’s case, he is considered a native of Anhui because his grandparents (and probably innumerable generations before them) came from this region of China. It is meant to inform his judgment, personality and provide the main reason Anhui Province is said to have experienced very high gdp growth during Hu’s tenure. He oversaw policies and spending decisions that gave a big boost to this once-poor area of China.  In US politics, this is known as “bringing home the bacon”.

And yet, from what I was told, Hu has little personal connection to Anhui. He was born and spent all his formative years in Jiangsu.  His grandparents emigrated there.  Then and now Jiangsu was among the most developed, economically successful areas of China, with a strong tradition of higher education and high professional achievement.

Hu’s spoken Chinese bears no trace of an Anhui accent, or any regional accent for that matter. His working years before becoming China’s party secretary were spent in various corners of the country, including Tibet and Guizhou, but never in Anhui. But, from what I was told, his parents raised him on Anhui food, and with a strong sense of identity as “安徽人”, or a person whose laojia is Anhui. My guess is that is you asked him to name his laojia, he would say “Anhui”.

China’s likely next leader, Xi Jinping, is a born and bred Beijinger.  He is about to embark on an important visit to the US, a kind of trial run ahead of his elevation to the top spot as Party Secretary later this year. He is son of a first generation leader of the Communist Party, and grew up, it is widely assumed, with all the perks available to a child of one of the country’s top officials.  And yet, his laojia is considered to be Shaanxi, the ancestral home of his father, and a place he was sent to at 16 years old, during the Cultural Revolution.

Shaanxi is the cultural and historical heartland of Han China. Xi, it is widely assumed, will bring to the job of China’s leader not so much the values of a Beijing son of high privilege and power, known in Chinese as a 太子党, or “Communist Party Prince” but the practicality and diligence of Shaanxi folk.

 When Chinese find out I’m American, they often follow up by asking “where do your ancestors come from?” In effect, I’m being asked to name my laojia. I offer the answer (in my case, Middle Europe) and also a quick discourse on why this idea of laojia hasn’t such resonant meaning outside China.  Americans tend to be far more interested in where a person was raised and schooled, rather than the locus of the ancestral burial ground.  Anyway, I often explain to Chinese that as a Jew, my ancestors were pretty much on the run for 1,900 years before disembarking from a ship on New York’s Ellis Island over a century ago. We have no ancestral burial ground. No home turf. I am, for all practical purposes, a person without a laojia.

That would never be possible – or acceptable – for a native Chinese. Laojia provides a middle layer of identity for all Chinese, between family and country. Yet, unlike those other two, laojia is often as much mystical as it is practical.

For many Chinese, not just the current and likely future leader of China, one’s laojia may be a place you’ve seldom, if ever, visited. And yet it’s also the root source of one’s values and preferences, shaping one’s choice of friends, profession, entertainment, food. In China, one can be of a place but not from it.


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China’s Porous Glass Ceiling – How Women Entrepreneurs Compete and Succeed in China

5 Comments / January 16, 2012

“Women”, in Mao Zedong’s memorable phrase, “hold up half the sky”. While not strictly the case in the business world, Chinese women do play a far more prominent role, both in starting and running big companies in China, than their sisters do elsewhere, particularly in the US and Europe.

According to a study last year by accounting firm Grant Thornton,  women hold 34% of the senior management positions in China, compared to an average of 20% elsewhere in the world. The percentages are also moving in opposite directions, with a greater proportion of top jobs in China going to women recently. Women held 31% of management jobs in China in 2009. Meantime, women are becoming less common in senior management in Europe and US, down from 24% over the same period.

And, no, it’s not just a case of women dominating “soft functions” like HR and accounting, as they often tend to do in the West. In China, 19% of women in management roles are serving as CEOs, compared to 8% elsewhere. A significant quotient of partners at private equity firms in China are women. The most talented and capable person in investment banking in China I know, Wang Yansong,  is female — even better, she works with me.

If there is a “glass ceiling” in China, it must be quite porous.

In my three-plus years in China, I’ve met far more successful big-time women entrepreneurs and bosses than I did in 25 years working in US and Europe. I’ve also been lucky enough to work with several, including one of China’s most well-known entrepreneurs, Mrs. He Yongzhi, the founder of the country’s largest spicy hotpot restaurant chain, 小天鹅, or “Little Cygnet”, with over 400 high-end restaurants across China.

Mrs. He started the business 30 years ago in a tiny alcove, with just five tables –no capital, no powerful backers and a competitor on every street corner. And yet, she has thrived. She invented the now-ubiquitous “yin-yang” twin-flavored stock pot commonly used not just in her own restaurant but in hotpot restaurants around the country.

Along with the restaurant chain, she also runs a food processing company, producing bottled hot sauces with her face on every label, and a large commercial real estate business, including five hotels in Chongqing, Sichuan and Tibet. Her daughter Weijia is a chip off the entrepreneurial block,  having started a high-end tea business called Nenlü.

Mrs. He’s  restaurant company has Sequoia Capital as an investor, and is planning an IPO next year that will likely make her into another of China’s self-made billionairesses. Already, half of the world’s self-made billionaires are from China. Over 10% of the richest businesspeople in China are women. That may not sound like much, but is light-years ahead of most every place in the world. In a typical working year, I will meet at least 10 women bosses who are well on the way to building an enormous fortune as founder and majority-owner of companies that may likely one day have an IPO in China.

Indeed, it’s one of the great joys of my working life, that I meet so many great “lady laoban”, as we call them, using the Chinese word for “boss”. I especially like meeting with women running metal-bashing businesses.  One of the more successful and elegant women bosses I know started and runs one of China’s largest private auto parts companies, making aluminum ventilation and heating systems for cars and large trucks.

At the factory, she wears a smock with the cotton elbow-protectors once in vogue among 19th century English bookkeepers. Her husband works for her, as head of the security team. Her likely successor? Her one daughter, a recent new mom, who runs the company in tandem with her mother. Both mother and daughter are warm, lovely, attractive, fully at ease talking to truck mechanics and engineers, or walking the factory floor.

It may be a coincidence, but many of the women bosses I know do not have sons. Only daughters. Did they work harder in their professional lives to overcome the stigma (then large, now thankfully smaller) of having only girl children? It could be. But, such Western-style psychological theorizing seems misplaced. China has more great women entrepreneurs because 30 years ago, as China was ending its costly experiment with Maoist socialism, there were new huge areas of money-making opportunity open to all.  Gender mattered less than ambition, diligence, persuasiveness, business acumen and leadership skills. China after 1978 was a commercial “tabula rasa”. There were few established business rules and basically no role models (positive or negative) for anyone to follow.

China traditionally is a male-focused society, with deep-set roots in Confucian thinking that put husbands and sons well above the rank of wives and daughters. In many ways, this mindset still persists in China. And yet, paradoxically,  a society that puts men on a higher social plane can also provide women entrepreneurs with something of a level playing field in business.

In the last year, along with the two lady bosses already mentioned, I’ve met women who started and now run successful companies that make high-end LED screens, lease cars, provide an online B2B transaction platform, make and export embroidered blankets to Williams Sonoma. Never once have I heard a complaint about gender-discrimination or even a hint that the company has been victimized by negative perceptions about female bosses.

In the end, starting a company anywhere requires a tolerance of — if not full bear hug embrace of — risk. Women, so I’ve read, are programmed from birth to shun risk. It’s meant to be the reason there are comparatively few women combat soldiers and motorcycle riders, as well as successful entrepreneurs.

Gender theorists obviously never looked closely at China. Equally, Chinese women weren’t taught why they were destined by biology to underperform men in the workplace, to start fewer businesses, to climb high on fewer corporate ladders. Spared knowledge of these “facts”, they’re in full pursuit of their dreams and ambitions.


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In China, Newspapers Can Still Thrive

1 Comment / December 19, 2011

Newspapers, as everyone knows by now, are a crummy business, being slowly but surely pounded to death by two major forces they can’t control. First, news is now available for free, instantly, online. So, no need to wait for – and pay for — tomorrow’s newspaper to find out what’s happened today. At the same time, Google and Craigslist have created a far more efficient, and generally far cheaper,  form of advertising online than traditional print advertising.

On the whole, it’s a very gloomy picture. But, there is one new newspaper business model that not only goes from strength to strength, it will likely continue to make big money for many years to come. It’s the free newspapers distributed on subway and metro systems. The first one appeared in Sweden in 1995. Shenzhen, where I live, this year got its first entrant, called “地铁早8点”( “8 O’clock” in English). These free newspapers seem inoculated from every pathogen that is killing off the big urban newspapers around the world like the New York Times, LA Times, Le Monde, South China Morning Post. 

Start with the fact they are free. That certainly makes it easier to find readers. Next, there’s guaranteed, efficient and low-cost distribution. In the case of 8 O’clock， the paper is handed out by reps or left in big piles weekday mornings at many of Shenzhen’s 137 subway stations. Based on my daily subway commute, I’d say the newspaper is now being read by well over 60% of the people on my morning rush-hour train. The newspaper is bulging with ads. By any standards, this is a both a business success and a repudiation of the notion that print newspapers are sledding towards extinction.

The key to success for 8 O’Clock is knowing who its readers are and what they want to read about. 8 O’Clock, like most free subway newspapers, attracts mainly under-40 office workers. They have very clear editorial tastes, and these differ in some key ways from the many newspapers that are now headed for the boneyard. For one thing, 8 O’clock doesn’t try to break major stories or even stay current on political or economic stories fighting for headlines elsewhere. Instead, it offers its readers a mix of brief articles about celebrities, sports stars, oddball “human interest” tales and the occasional local scandal. Around half of each page is pictures, either advertising copy or outsized art work accompanying the short articles.

8 O’Clock is owned by the biggest traditional newspaper publishing company in Shenzhen, called Shenzhen Press Group. It has ten other newspapers in Shenzhen, all using the conventional paid-circulation model. This offers some obvious traps for Shenzhen Press Group, most obviously in selling a product at newsstands with some strong similarities to the one it’s giving away for free in subway stations.  But, against that, Shenzhen Press Group is reaching people with 8 O’clock that most likely never buy paid-for newspapers. What’s more, Shenzhen Press Group already has an in-house advertising team and deep knowledge of the local market to sell ads efficiently in 8 O’Clock. A full-page color ad sells for around USD$25,000-$35,000, depending on the day of the week and placement. Readership is somewhere around 300,000 a day.

Beijing, Shanghai, Shenyang and Guangzhou all have their own free subway newspapers. All seem to be thriving.  Other countries also have them, including US, UK, Germany.

China is the ideal place for free subway-distributed newspapers to thrive. Start with the fact, of course, its cities are huge and subway ridership dwarves that of most Western cities. But, as important, the newspaper industry in China is relatively new. Chinese aren’t imprinted in the way that so many Americans and Europeans are about what newspapers are for. The popular ones see themselves, unashamedly, as for-profit vehicles: an effective advertising medium. Not as a civic trust.

The editorial goal is to get enough people reading articles at the top of the page to deliver big audiences, efficiently, for the advertisers renting space at the bottom. For 8 O’clock, the advertisers are mainly large auto brands, hospitals, realtors and big chain stores all of whose businesses are thriving in China’s booming domestic economy. 

In cities like Shenzhen, Shanghai and Beijing, purchasing power, along with property prices, are reaching first world levels. There’s massive net migration into large cities in China, compared with stagnant, or declining populations in most big Western cities. The subway systems are themselves mainly new, with extensive networks – 14 lines in Beijing, 11 in Shanghai, five in Shenzhen, with two more on the way. As the systems grow, so too will the profits of the free subway newspapers like 8 O’clock.

A generation ago, there was basically only one newspaper of any importance and readership in China, the Communist Party’s People’s Daily (“人民日报”).  It’s still published, and has changed little down the years, a slim sheaf of turgid and often theoretical writing barely leavened by photos or ads. Meanwhile, thousands of newspapers and magazines have entered the market with a broad range of content.

All major media in China are still subject to censorship and, in theory, under the control of the Party’s propaganda department. But, 8 O’clock has ample scope to provide what Shenzhen’s subway commuters are after, at a price they can’t argue with.  A financially healthy newspaper serving a financially prospering city– 8 O’clock will keep waltzing compared to the wretched papers in the US and Europe.

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Chengdu — Great City, but Where Are the Great Food Companies?

Leave a Comment / October 4, 2011

Ge dish from China First Capital blog post

Among major cities in China, Chengdu takes the prize as most pleasant, livable,  comfortably affluent, relaxed and charming. I arrived back here today. I’m reminded immediately there’s much to like about Chengdu, and one thing to love: the food.

Chengdu is famed for its “小吃”, (“xiaochi”) literally “small eats”. To translate 小吃 as “snack”, as most dictionaries do, doesn’t even remotely begin to do it justice. A 小吃  is a often one-bowl wonder of intense, jarring flavors. They not only take the place of a full meal with rice, they make the Chinese staple seem almost superfluous, a waste of precious space in the stomach.

There are about a dozen小吃 that can stop me in mid-stride, any time of day. These include several varieties of cold noodles, including the bean jelly ones called 凉粉, literally “cold powder”，as well as dandan noodles served dazzlingly hot, in both senses of the word.

My favorite 小吃 , by a wide margin, is 抄手 , literally, “to fold one’s arms”. It’s an odd name, since the last thing I’d ever do when I see a bowl of抄手 in Chengdu is fold my arms. They are always thrust outward, in anticipation.  抄手 is a bowl of wontons steeped in a fire-engine red soupy sauce, optimally with enough Sichuan pepper corn to numb the tongue all the way down the gullet. This frees up the nose to do the real work of decoding all the subtle flavors.

Offiically, Chengdu has a per capital income of around $5,200, about half Shanghai’s. But, I’d prefer living and working in Chengdu any day. So would many Chinese I know. The economy is doing well, despite some geographic disadvantages. Chengdu is the most westerly of China’s large cities, and so isolated from the most developed regions of China. It’s over 1,000 miles to Shanghai, Beijing, and almost as far to Shenzhen.

Chengdu is doing well economically – though you don’t always have a sense this ranks as high on the list of civic priorities as drinking tea and playing mahjong. The electronics and telecom industries are both doing well. Quite a few companies have received PE investment.

The one industry, however, that is still relatively undeveloped is the food business. This is odd. By logic, Chengdu should be a center of China’s food processing and restaurant industry. Not only is it a great food town, situated in a very region valley producing some of China’s best fruits and vegetables, but it is also capital of Sichuan Province.

Sichuan food is almost certainly the most popular “non native” cuisine across China. Within a mile of where I live in Shenzhen, there are probably over 50 Sichuan restaurants. It’s the same in Beijing, Shanghai and most other major cities.

There’s an innate association in Chinese minds between Sichuan and good food. In this, Sichuan reminds me a lot like Italy. Italian food is prized across all of the Western world, and as a result, some of the Western world’s biggest and most successful food companies are based in Italy. Among the larger ones are Barilla, Bertolli, Buitoni, Parmalat, Ferrero. These, and thousands of smaller ones making wine, cheese, salami, all benefit from the widespread popularity of Italian food, and the high market value of associating a food brand with Italy.

Chengdu and Sichuan should be no different. It should be the capital of China’s food processing industry. But, as far as I can tell, there are as of yet no great food companies or food brands based there.  If you shop around in Chengdu, the food products being marketed as “authentic Sichuan food ” are mainly an assortment of beef jerky, along with sweet and savory biscuits made from beans and peanuts.

There’s nothing wrong with any of these products, but there isn’t a big brand national brand among them. The mass market is going unserved.

Let’s look at two of the biggest food product categories where Sichuan brands should predominate: chili sauce and instant noodles. Each of these product areas have sales of billions of dollars a year in China. Yet, the leading brands come from outside Sichuan. In the case of instant noodles, the leaders are mainly Taiwanese and Japanese.

In chili sauce, the biggest brands all seem to come from Guizhou province. This, particularly, should cause a collective loss of face across Sichuan. Their spicy food  “owns” the palettes of hundreds of millions of people and yet the main brands of chili sauce in supermarkets come from the poorer province to its south.

The companies selling bottled pre-made Sichuan sauces (for popular dishes like Gongbao Jiding, Mapo Toufu and Yuxing Rousi) mainly come from Taiwan, Shanghai, even Hong Kong. It’s as if the most popular brands of spaghetti sauce were made in Brazil. Chinese food companies all over are eating Sichuan’s lunch.

This situation is unnatural and, I’d hope, unsustainable. Sichuan companies should by rights eventually dominate the market for many food products in China, much as Italian food companies are among the largest in Europe.

Some lucky PE investors should someday make a lot of money backing Sichuan food companies. Me and my company would love to play our part in this. Ambitious food entrepreneurs in Chengdu, call us anytime — 0755 33222093. If ever there were a billion-dollar unfilled market opportunity in China, this would be it.

 

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China’s Tax Revenues: An Embarrassment of Riches

Leave a Comment / July 25, 2011

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You’ve got to love the timing. With U.S. mired in a debt and spending crisis, with tax revenues stagnant and its government about to run out of borrowed money to spend, the Chinese government just announced that its fiscal revenues during the first half of 2011 rose by 29.6% compared to a year earlier. One country is a fiscal train-wreck, the other a fiscal gusher.

China’s tax revenues are surging for a host of reasons that set it apart from the US – the economy is booming, and in particular, businesses are thriving. According to the Chinese Ministry of Finance, profit taxes are growing especially quickly. Income and corporate tax rates are stable, at rates far lower than the US. China levies a nationwide VAT, while most of the US charges sales tax. Consumer spending is growing by over 20% in China, while it’s basically flat in the US.

To all these must be added another crucial difference: China is modernizing so quickly, that every year money pours in from new sources. China doesn’t need to raise tax rates to increase tax revenue. It just allows its citizens to get on with their lives.

Take auto sales. A decade ago, China produced and sold about two million cars. This year, it will sell about 20 million. China passed the US two years ago to become the world’s largest auto market. Since then, sales have grown by a further 40%.

Along with creating some of the world’s worst traffic congestion, all these new car sales do wonders for the country’s fiscal situation.  Start with the fact that every car sold in China has not just a 17% VAT built into its price, but a host of other taxes and levies. A consumption tax adds as much as 40% more to the sticker price depending on the size of the engine. Customs duties are also levied on imports.

These all add up fast. The government’s tax take from the sale of a single Mercedes-Benz can easily top Rmb325,000 (US$50,000). Last year alone, sales of Mercedes-Benz in China doubled. This year, Mercedes will sell about 180,000 cars in China. Total tax take: about USD$1 billion. Keep in mind that Mercedes-Benz has less than 1% of the Chinese market. BWM, Porsche and Lexus are also doing great in China. While they are all doing well, the Chinese government does even better. The government earns far more on the sale of every luxury car than the manufacturers do.

The sales and consumption taxes are just the start. Most news cars in China are sold to new drivers. That means, every year, there’s a significant net increase in the consumption of gasoline. Each liter of gasoline also carries a variety of different taxes – VAT, consumption tax, resource tax. Plus, almost every gas station and refiner in China is owned by companies majority-owned by the Chinese government. So, profits at the pump flow back to the government.

At the moment, the gasoline price in China is about Rmb7.5 per liter,  or Rmb30 ($4.60) per gallon. Figure the Chinese government is making about Rmb10 ($1.50) per gallon sold in tax. Each new car sold this year will likely contribute an additional $500-$600 in fuel taxes, or about Rmb100 billion in total. Again, a big chunk of that will be a net increase in fiscal revenues, since there are so many new drivers each year.

Think the same for sales of new apartments, air-conditioners, iPads and iPhones, plane and high-speed train tickets. Each one has all sorts of taxes built into its sales price, and then an annuity of future tax revenues from energy taxes, fees and assessments.

In the US, taxes and spending are so high, people grow more and more reluctant to spend. Huge budget deficits today, as Milton Friedman long ago established,  creates the expectation of tax increases tomorrow. Americans adjust their spending accordingly. Not so in China. Chinese keep spending and the government reaps the bounty.

As flush as the Chinese fisc now is, tax revenues represent only one part of the government’s huge cash hoard. To begin with, there is the over $3 trillion in official foreign exchange reserves. This money contributes little to no benefit to the economy as a whole, except bottling up pressure on the Renminbi to appreciate against the dollar. It’s basically money buried in the backyard.

The government also owns significant – often controlling — shares the country’s biggest and most profitable companies, including SinoPec, China Mobile, China Telecom.

Net profits at the 120 biggest centrally-controlled Chinese SOEs rose by 14.6% year-on-year during the first half of 2011, reaching Rmb457.17 billion yuan ($71 billion) . These 120 SOEs are meant to pay taxes and levies of almost twice that, Rmb850 billion, up 26.4% from 2010. No one quite knows how much of that money actually reaches the Chinese Treasury. But, of course,  the money is there, should it be needed – in a way the US Social Security “Trust Fund” most assuredly is not.

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Real Estate Prices in China – For Many, Higher Means Happier

Leave a Comment / July 18, 2011

China’s government is engaged in mortal combat to control rapidly-rising real estate prices. Or so you would believe from reading the newspapers and listening to all the economic commentary. But, it’s not entirely true. The reality is, China’s government is trying to navigate a tricky path between the interests of current homeowners, and those who’ve yet to join the housing ladder. Current homeowners, of course, are perfectly happy for prices to keep rising. In today’s China, homeowners are one-and-the-same with the country’s most important political constituency.

When I first came to China in 1981, this country was, both in its rhetoric and policy, still a nation of and for “workers and peasants”. These “have-not” groups enjoyed preferential access to housing, jobs and higher education.

Today, most power belongs to society’s “haves”, the urban and educated population that creates and captures the benefits of China’s remarkable economic growth. The government must seek to keep this group content. The easiest way to do this, of course, is to create policies and conditions where personal incomes continue to rise. Since most personal savings is tied up in housing and the stock market, the government must focus heavily, in ways perhaps no other government in the world does,  on measures that produce favorable outcomes for people with money tied up in property or shares.

Overall, China’s government has been consistently successful doing this. With housing prices, they’ve perhaps been a little too successful, since the policy mix has created a situation where prices continue to rise by over 50% on an annualized basis, and are now often higher, per square meter, than they are in most of the US and Europe. For the tens of millions who have owned property for more than six months, this translates into very significant increases in personal wealth.

In short, for every person currently priced out of the housing market, there maybe three or four who are feeling flusher than they ever have. That means, if you could measure such things, greater net happiness in China when property prices are rising.

China’s government, if it wanted to,  has the power to drive down housing prices in a hurry. It owns all the land in China. By releasing more of it for residential development, the certain outcome would be to lower or even roll back the growth of housing prices. Yet doing so will also have wealth effects on those who already own.

The other policy levers at the government’s disposal – introducing property taxes, restricting people from buying more than one residential property, raising minimum down-payments,  – can have some impact. These are the main tools the government is now using to moderate housing price inflation. But, all evidence is, these steps aren’t having a major impact. Property prices continue to rise, if less explosively than they did in 2009 and 2010.

Most of the talk from government is about increasing affordable housing, especially in cities. But, the policy mix is still designed in such a way that prices should continue to move upward.

Hong Kong is a constructive example. There too, property prices are high and moving higher, and the government is tinkering with policy changes to slow rapid increases. But, high property prices have been a fixture of Hong Kong life for a generation.

The Hong Kong government owns most of the undeveloped land. It tightly controls the amount of new land auctioned each year. This maximizes the government’s profits from land sales, while sustaining upward pressure on property prices overall. This makes all current owners, from large developers like Li Ka-shing’s Hutchinson Whampoa and Cheung Kong Holdings, happy as well as the two-thirds of Hong Kong citizens who own their own homes.

Home ownership in China is not quite as high overall. But, it is likely just as high, if not higher, among the huge part of China’s population whose political and economic clout is greatest. China is wise to want to extend to more people the benefits of home ownership. But, the next time you hear that China’s property prices are rapidly rising, the meaning is: the country’s very many haves now have very much more.

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China’s Most Profitable Industry Becomes One of the Toughest

4 Comments / July 7, 2011

Chinese real estate is no longer the easiest legal risk-adjusted money-making business in the world. It’s been a swift reversal. For the better part of twenty years, there’s been no simpler way to amass a great fortune than developing property in China.

The business model was as simple as it was profitable: acquire a piece of property from friends in government at a fraction of its market value, mortgage the property heavily with obliging state-owned banks, sell out most of the units (either offices or apartments) within weeks of construction beginning, and then pocket returns of 500% or more before the building was even occupied.

Continuously rising property prices, often increasing by 10% or more per month,  provided incentive to hold onto some units for later sale. A final wrinkle was to demand a cash advance from the construction company when awarding the building contract, so limiting even more the amount of capital needed, and improving return-on-equity even more.

There was just about zero risk in deals like this. Then, the Chinese government began clamping down, starting gingerly about a year ago and then with added ferocity in recent months,  in an effort to restrain property prices and overall inflation. At this point, what was once the easiest business in China has become one of the hardest. Sweetheart land deals are far more rare, as the central government in Beijing is no longer turning a blind eye.

More importantly, banks have all but stopped lending to property developers. This has dried up liquidity in an industry that was for many years awash in it. The projects getting built now, for the most part, are those where little or no bank debt is required. That means heavy upfront equity investment, or taking money from loan sharks who charge interest rates of 25%-30% a year. This fundamentally alters the arithmetic of a real estate deal in China. The more equity and high-interest debt that goes in, the lower the returns and, it seems,  the more likely a project is to hit problems.

And problems have become the norm. Another government change, little reported but absolutely crucial to the change in fortunes of the real estate business in China, is that it’s no longer easy and cheap to get current residents off the land, so it can be sold at a high price to a developer. New rules make it very expensive and risky for any developer to undertake this process of relocation and demolition.

Any delay, and delays are rampant, can quickly drain away a developer’s cash. For example, if one old tenant refuses to take the relocation money and move out, it is no longer a simple thing in most instances to get the local government, or hired goons, to force them out. Until all old tenants are resettled, no construction can begin. This can push back by months or even years the date that developers can begin pre-sales. Meantime, you keep paying usurious interest rates to lenders who have taken the whole project, as well as many of other unrelated assets, as collateral.

A final nail: residential real estate prices are now rising far more slowly. This is the result of tighter mortgage rules, property taxes in some cities, as well as new regulations that limit the number of apartments people can buy. In Beijing, for example, you need to prove you have paid local Beijing taxes before being allowed to buy.

Of course, taking the easy money out of real estate is a prime policy objective of the Chinese government. That the government would be successful in this was never much in doubt. The speed and geographical scope of the impact, however, has caught a lot of people (including me) by surprise. Projects that six months ago looked like sure things are today struggling. The sudden evaporation of bank finance, in particular, is playing havoc. Banks in China are state-controlled. When they responded slowly, earlier this year, to government suggestions they slow the flow of funds to the real estate sector, the government took more active measures, including raising six times banks’ reserve requirements.

Rocketing property prices are a major contributor, directly and indirectly, to inflation, which is now, by official figures, at its highest level in China in over three years. So, the government’s actions had a broader purpose than altering the return formula for real estate investment in China. At the moment, though, that’s been the main impact, to make it far harder to do both residential and commercial real estate projects in China. When and by how much inflation will be curbed is unclear.

The bigger question is: has the game changed permanently in Chinese real estate, or will things revert as soon as inflation is down to where the government wants it to be. The rising real estate prices of the last 20 years have not only helped the country’s real estate barons. They have also been a main source of rising middle class wealth in China. That’s where the government policy becomes more an art than science: how to strip away real estate developers’ easy profits, while keeping the middle class feeling flush and contented. I’ll write about that in a following blog post.

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Entrepreneurship in China– The Fuel in the Economy’s Engine

1 Comment / April 26, 2011

Fish bowl from China First Capital blog

China’s only abundant and inexhaustible natural resource is the entrepreneurial talent of its people. Nowhere else in the world can match the number of talented businesspeople, both in absolute numbers and as a share of the active population. That’s what I’ve learned in a 25-year career working alongside great entrepreneurs in the US, Europe and Asia. Today’s China is the most entrepreneurially-endowed place in the world. What that means, above all, is that China’s economy, propelled by robust entrepreneurial activity,  will prosper for the next several decades at least.

Entrepreneurs everywhere seem to share a common gene, and have more in common with one another than they do with the rest of the population in their home countries. They are more tolerant of risk, more compelled to try or invent new things, more able to see opportunities for profit, especially when they are invisible to others.

But, in China, entrepreneurs have some unique characteristics compared to those in the US and Europe. For one thing, until comparatively recently, China’s economy was a near-perfect socialist vacuum in which entrepreneurship could not survive.  The economy was almost entirely in state hands. Laws giving equal treatment to private companies were only introduced in 2005. Decades of pent-up entrepreneurial energy were unleashed. More great private companies have been started in the last ten years in China than in any other place in history.

We are still in the early years of the Big Bang of Chinese entrepreneurship. Everyone in the world is feeling the effects. Within China, private entrepreneurs now supply much of what China’s vast consumer market buys. Outside China, much of what’s labeled “Made in China” is produced in factories started and run by these new entrepreneurs.

There are some other important ways in which China’s entrepreneurs are different than those in US and Europe. A very minor percentage of China’s entrepreneurs are university graduates. They build their companies with almost no capital, and no access to bank credit. They face daunting challenges unknown to entrepreneurs most everywhere else: an absence of clear commercial laws or intellectual property protection, very burdensome tax and labor rules, holdover policies that give state-owned companies significant advantages.

Despite it all, every year, more of China’s population are going into business for themselves. Not all will build billion-dollar businesses. But, more will do so in China over the next several decades than anywhere else.

Partly, it’s simple math: China has both a huge domestic market and is the world’s largest manufacturing and exporting nation. But, these factors are themselves the product of China’s earlier entrepreneurial success, not a precondition for it. Earlier entrepreneurs created the fertile environment for today’s new private companies to thrive. The process is cumulative, and very fast-moving.. I see this every day in my work. We are meeting more great entrepreneurs now, on a weekly basis, than we did three, six or twelve months ago.

Another fact stands out when I compare these Chinese entrepreneurs to others I’ve worked with in the US and Europe. Chinese entrepreneurs do most everything single-handedly. They build companies without relying on a big management team or a circle of advisors. Decision-making is mainly based on hunch and experience, not on market research or focus groups. Even large private companies in China are managed like sole proprietorships. Nothing of importance is delegated. One person controls all the decision-making levers, casting the one and deciding vote on any issue of importance to do with operations, marketing, finance, strategy, sales. They are lone navigators, steering their businesses through very tricky waters, dealing with government officials, suppliers, customers, as well as their own employees.

Since starting China First Capital three years ago, I’ve been fortunate enough to meet several hundred outstanding Chinese entrepreneurs from dozens of different industries. Most are cut from the same cloth — crisp, confident, charismatic. With few exceptions, most do not have college degrees or much experience working for anyone else. They are born entrepreneurs.

Take one boss I met recently. He began his working life 30 years ago, after high school, as a trader. He was good at it, and saved enough, eventually, to go into manufacturing one of the products he was selling as a wholesaler to others. He moved up quickly, from producing basic low-margin commodity products to investing in his own R&D. He kept plowing profits back into the R&D work, and then to build new factory lines to produce a range of unique, patent-protected products he invented. These products deliver higher margins and target a larger, richer market than anything he previously manufactured.

The business is now growing very swiftly. Also typical, his son has joined the business, after getting a college degree abroad.  This boss, like most others I have met, knows how to work the system to his maximum advantage. His new products let him qualify as a high-tech enterprise, and so pay a much lower corporate income tax rate. The local government has shown its further support by selling him a large tract of land to build a new factory on, at a fraction of its market price.

This boss, somewhat uncommonly, has a very strong management team around him to manage finances, factory production and marketing. He is the force of gravity holding whole business together. It’s hard to imagine anyone else, except perhaps one day his son, could run this business as well. That’s another characteristic shared by most good entrepreneurial companies in China – they are never quite as successful once the founder steps down.

Another distinguishing trait of entrepreneurship in China – there are far more women bosses here than I ever saw in the US or Europe.  The ones I’ve met, along with being successful entrepreneurs, are also all quite elegant, attractive, even seductive. Those aren’t words usually associated with entrepreneurs anywhere else in the world.

According to the magazine China Entrepreneur, there are currently more than 29 million female entrepreneurs in China,  or about 20% of the total number of entrepreneurs in the country. Overall, China has more entrepreneurs, male and female, than most countries have citizens.

China’s economy continues to perform at a level never achieved by a major economy. Can this continue? I believe it can. The most emphatic reason is the entrepreneurial genius of so many of its citizens.

 

 

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