Beijing - May 2001
By Gilbert Van Kerckhove

This document is an abridged version of a more detailed analysis and was used as a handout for a seminar organized by BFISC on 19 June 2001, see program attached and introduction of the speakers. The presentation was done with slides that include other and updated details.
The content has not been changed - to see in how far the analysis still holds…

Outline

Once more China is entering a period of scrutiny by foreign politicians and businesspeople. Questions raised are mostly about China's WTO membership and China-US relations. Fewer analysts map the region and the "dominoes" to identify the complex scenarios where toppling one domino could - or could not - bring the others down.
We can easily identify a number of risk factors that could lead to a serious economic setback for China and even a general contagion. It seems most likely the world economy has not yet reached the bottom of the downturn, according to our analysis of early May 2001.
I remain moderately optimistic, but we cannot ignore the volatile environment and the growing complexity in the new interdependent global economy. While the USA has a major say in the world economy it could weaken its role model by ignoring globalization trends and the concerns of other economic powers. While one can easily criticize the slow liberalization of the European markets, Europe has the advantage of slowly but steadily going forward. If a domino effect destabilizes the might of the US economy, Asia could gradually enhance its economic links with Europe that generally has a more careful approach to political sensitivities in Asia. The sometimes erratic and impulsive behavior of some of the powers involved, fuelled by a lack of mutual understanding, increases the volatility.
Some thoughts and highlights on the many factors that could lead to different scenarios.

Looking back to 1997 and the news media

When in 1997 the financial crisis started, China officials initially denied they felt concerned. Actually, China was one of the first to get seriously worried. It quietly assembled a think-tank to evaluate the situation in Southeast Asia and to take measures to minimize effects.
China abruptly backpedaled on the expected gradual convertibility of its currency, creating at the time a lot of headaches for bankers and raising both suspicion and disappointment among businesspeople.
The economists understood the danger: monetary instability, leaving the door open for insufficient control of the economy. The 2001 White Paper of the American Chamber praises "China's careful management of foreign debt, high foreign currency reserves and capital controls ... which protected the nation from the worst effects of the financial crisis".
The move illustrates how much China is aware of the mechanism of the world economy. When I look at how much the average US businessperson can learn about Asia through the US media, I am not surprised how little they understand. On the other hand, the US has some of the best China analysts and news sources.
Looking at how much information is available here to Chinese and foreigners, the picture is quite different. The official Chinese and English press goes to great lengths to keep its readers aware of what is happening in the US and other important markets. It is thus a mistake to assume China is not aware of what the forces are out there that can affect its own destiny.

WTO membership, laws and agriculture

One of the hot issues is China's WTO membership. Is the government having second thoughts? Is (at least) part of the Chinese government unwilling to continue the economic opening? Many countries were alarmed when China started to show doubts about the "firm agreements" recorded during the earlier WTO talks.
They are not going back on opening the economy. My best guess is that China will become a WTO member in 2002. China realizes it needs to implement a proactive strategy to shield the country from the risks it sees, being a global economic recession and its lack of readiness to enter WTO.
The Chinese WTO team was probably a bit too eager to reach a deal. Once the administration started to review the fine details, it understood its gigantic bureaucracy was not ready to implement changes and it was a potential agricultural threat. With a world recession looming the consequences could be disastrous.
Existing laws and regulations are still hard to enforce outside of the major cities. But now they will have to be drastically reviewed to be in compliance with WTO. A Gargantuan task - but even more so in terms of acceptance and application by the lower ranks of the administration. China started the revision of laws, in doing so, more new questions arose. Jumping into WTO with a poor legal structure seems indeed a dangerous undertaking and would not benefit foreign investors either.
A vulnerable and sensitive part of the economy is agriculture. The "rural population" is said to be 900 million, other figures state 600 or 330 million farmers. Does it matter? The lowest figure is said to be half of the labor force. That's a lot of people. Contrary to general assumption, Chinese farmers are not efficient - not in terms of output per capita. On the other hand for certain crops they have very high yields per-unit-area.
China does export a lot of agricultural products, but that is not the whole picture and with tariffs coming down a lot is about to change: "Frankly speaking, our major farm products are not very competitive in the international market. Even the price of rice was about 10% higher than the international market price" (China Daily).
With too many farmers, high rural underemployment and an often unfair tax burden, WTO rules, if applied without caution, could lead to very serious social instability in rural areas. On top of that the areas are littered with loss-making and outdated factories.
The government has been working hard for years to improve the rule of law and to impose fair tax levies in the countryside. It is much concerned by a sudden deterioration in the rural economy and rising popular discontent if "the floodgates are opened".
At the same time the government is trying to lift the growth of farmer's income which has been dropping in recent years from 9% (1996) to 2.1% (2000), making the gap between annual rural income (US$ 271.44) and urban income (US$ 756.6) even larger, an obviously dangerous situation. Raising the price of produce or increasing subsidies will not fit well in a WTO economy.
Foreign countries ought to have more understanding for their concern. Both US and European farmers are the first to protest when their livelihood is threatened.

Recession? What's in a name...

Is a recession coming? Or call it "economic downturn", who cares? What Asia does know is that exports and manufacturing are barely starting to feel the slide and that the worst is yet to come. Asia checks the orders and tries to figure out how to survive.
Should we listen to all the soothing talk from the so-called "specialists" that the worst is "nearly" over? The fools of a year ago are the geniuses of today and vice versa. Financial advisors are the worst in predicting the future as they are richly paid to keep the market high. Enlightening studies are available on their track record; IPO disasters of the past year give underwriters reason to blush. At least now some have the courage to reward their analysts if they rightly recommend a "sell". But they are in the minority.

Dominoes all over the place

There are some shaky dominoes on our table. In fact we have no clue if any will fall - and if it will start a chain reaction. If we want to have a better picture of China's future we need to understand the many inputs into the equation. Obviously the US and Japan demand most attention.

Recession? Economic downturn?

Whatever our inkling, signs abound we face some tough times. "There is a recession coming if people believe it will come".
Looking at recent indicators and comments in the local and international press we read different messages.
According to the IMF the world economy is in a "critical" state at present but should start to recover later this year - no reason to panic.
The Economic Cycle Research Institute (USA) feels, recessions now appear to be unavoidable in the USA, Japan, Korea and Taiwan, which together represent half of the world's GDP. "What's troubling, there are no obvious areas of stronger or rising demand in other parts of the world that could help offset the weakness being felt everywhere else".
The OECD cuts growth forecast for 2001 from 5.8% to 4.2% for Korea, with foreign investment falling 63% in April. It cuts its forecast for global growth this year but said activity would pick up next year as lower interest rates in the US stoked a recovery.
Stung by sagging US demand for their exports and worried by a falling Yen, ASEAN ministers review growth from 5.3% in 2000 to 3% in 2001. ASEAN countries are worried that China's entry into WTO may divert trade away from their economies, still suffering from the '97-'98 crisis, and find the global outlook for 2001 significantly more adverse, with the slowdown in the US, lower growth in Europe and problems in the Japanese economy.
Taiwan's industrial production and export orders fell in March and unemployment climbed; exports are not expected to rebound soon and manufacturers are moving production facilities to China to cut costs.
Standard and Poor's reckons Asian bank problems are not over yet as some haven't fully recovered since '97-'98 and are particularly vulnerable for any downturns such as the current US-led economic slowdown. "Recession looms large in the US. This could be deadly, because when you start seeing actual drops in employment, people get really scared that they could be next; this could turn into a real recession".
Singapore: is bracing for a harsh future according to survey, warning on rising unemployment with electronics exports hardest hit by US-led economic retreat.
JP Morgan Fleming Asset Management comments "US corporate profits hit by slowdown"; "There will be very few signs of recovery in the second half".
Goldman Sachs & Co. strategists have advised European private clients in April to increase equity investments amid optimism over US interest rate cuts.
The Asian Development Bank estimates China and India would scarcely feel the troubles in the US and even Southeast Asia will suffer only a temporary setback - a moderation in the pace of economic growth, not a collapse.

What can regenerate (again) industrial growth?

I am afraid we are not yet at the bottom of the downturn. What's more, why should growth pick up again? In the past years the "fabulous growth" was mostly fuelled by the dot.coms, inflated expectations and irrational behavior in stock markets, the Internet, telecommunication and related activities.
It is just a repeat of the other big boom and bust in history: railways.
There is no such thing as "a free lunch". The Internet is in its infancy, we do not yet scratch the surface. It is stuck in a utopia of "should be free". Cute, but somebody has to pay the bill.
The folly with the sales of 3G licenses is just now starting to become "evident". The governments "killed the goose with the golden eggs". The industry will need more time to mature.
As long as a correct commercial mechanism is not put in place to regulate the Internet (and charge for it in a correct way), no "Killer Application" will break through. Demand for bandwidth will remain chaotic (we need it but we don't get it while there is a "glut"). Telecom and other companies will fail to grow. The impossible is already starting to happen: websites start charging money.
I am not convinced by the so-called increase of productivity through the Internet, email, personal computers and other gimmicks. We still have to invent "THE" personal computer. I wonder what people will say about our PC (or my Mac) twenty years from now.
What else can we expect to shake up the markets? The future we are waiting for is most likely the new era of IT and telecom.

The US economy and the dollar. Where is Europe?

It is still hard to find a solid reason why the dollar remains stubbornly high. Looking at the US trade deficit (about one billion per day), I still feel the dollar should go down. But it simply does not. But if dominoes start falling and the dollar loses strength, what will be the impact on China?
It would probably rather help China's trade, as exports would become more competitive with the Renminbi pegged to the dollar. Imports in euro would become more expensive. Much will depend how China rearranges sourcing of imports. As for foreign investment: a trickier question. China could also start building up reserves in euro - what they have been reluctant to do till now.
Some analysts simply reject the "rhetoric" from Brussels that the whole market is wrong on the euro and that Europe is the "World's growth locomotive" (Chancellor G. Schroeder). They blame Europe for being too slow in liberalizing its economy and further opening trade. They could be right. What we can hope for is that in a global slowdown, Europe will be cushioned by what they call its "protected fiefdoms".
Actually Europe could, as such, be a more "stable" trade and investor partner for China - being slow-moving sometimes has advantages... Analysts also point out, Europe is now less dependent on the US changing fortunes. "It used to be the case that when the US caught the cold, Europe got pneumonia. But those times are over". The European Commission estimates that the 12 countries now earn little more than 2% of their national incomes from exports to the US. Also, Europe does have a tremendous economic potential that is waiting for the "great leap".
The press gives ample attention to the outlook for exchange rates.
"US has the highest trade deficit in the history of the world, ... but it is outweighed by the determination of foreigners in general, and Europeans in particular, to acquire US assets and get into the great boom". Why the dollar remains strong despite the tech bust? No Euros to hold in your hand and....Russian gangsters. The "money laundry theory" comes back in the press with quite convincing arguments. What if next year they all go back to euro?
Franco Modigliani and Robert Solow (Nobel Price for Economics): at the end of 2000 the US trade deficit reached 4% of GDP. US reserves amount to US$ 60 billion, compared to a trade deficit of US$ 400 billion. A flight from the dollar could produce a steep devaluation leading to a wage and price spiral. Other sources mention a trade deficit of $ 435 billion.
Analysts fear rising labor costs in the US could fuel inflation, the main threat to the dollar.
"Yen unlikely to drag down Renminbi", Chinese Finance Ministry comments, in view of the past performance of Chinese exports during the Asian financial crisis in 1997 and China's increased reserves now at US$ 165.5 billion (end 2000). At the end of March 2001 China's foreign reserves increased to US$ 176 billion.
Many people feel burned by the stock market and are reluctant to jump back into stocks in the near future. While there is actually a lot of "investment money" around, it is sitting tight. IPOs are out of fashion.

China's own stability

An excellent China Case Study by the University of Chicago /GSB (Spring 2001) assumes a rather positive outlook for stability, an assessment I overall agree with. Nevertheless we should be aware the government is constantly walking a tightrope and booby traps are all over the economy and politics. For so many years China has constantly battled wildfires in a crisis atmosphere, all being denied with a brave face, "all being well".
I could list many explosive domestic and other issues. But in the past twenty years China managed to avoid or overcome major setbacks - often through ruthless policies and a "take no prisoner" attitude. It is often difficult to accept the "Chinese way" in guiding a population of 1.3 billion. I have one simple reply: "How would you do it, and could you do it better?" I just hope China will continue its "mission impossible".
Most important for China will be to offer attractive conditions for foreign investors - one more reason China cannot close the door. It also needs foreign business and investment to keep its growth at a certain minimum level to defuse the "booby traps".
Total value of foreign trade in 2000 reached US$ 474.3 billion, exports being 249.2 billion. A large share of exports (and even imports) actually came from foreign investments in China.
In 2000, GDP growth was 8% and in the 1st quarter of 2001 stayed at 8.1%. China still expects the use of FDI (Foreign Direct Investment) to increase 5% over last year despite the gloomy world economic outlook, according to the Ministry of Foreign Trade (MOFTEC).
It is difficult to unravel China's statistics for used FDI, Hong Kong and BVI mask a host of other countries. In the total of US$ 40.77 billion (year 2000) of used FDI the top ten were Hong Kong, USA, Virgin Islands, Japan, Taiwan, Singapore, Korea, Germany, UK and France.
To maintain growth, the government has continued to stimulate domestic consumption. One neat trick is the "Holiday Economics" to boost tourism and consumer spending through "Golden Weeks".
New gigantic projects are regularly launched. After Three Gorges follow the West-East Energy Transport projects (gas, electric power), the Guangdong LNG network and many more. If Beijing wins the bid for the 2008 Olympics, China Development Bank intends to loan US$ 7.25 billion to the Municipality to help the bid and for construction.
The government will also use those tools to soften the impact of a possible downturn in the world economy. But again, many projects will require foreign investment, financing and technical support.

US-China relations

All eyes are fixed on US-China relations. Both sides quarrel constantly. The US and its media never fail to criticize China for something, while they mostly skip similar issues in other countries. China is obviously "the winner" over India for attention in the US media. Why not India? Obvious: in 2000 foreign investment in India was about one tenth of China's US$ 40.7 billion; the USA buys one third of China's exports and is China's No. 2 trading partner; China is No. 4 trading partner for the US.
According to China Daily, year 2000 exports to the US were at US$ 52.1 billion and imports at 22.4 billion; US investments till 2000 were estimated to be $25.6 billion.
American sources quote varying figures for the same period. Total trade goes from $100 to 123.9 billion with imports to the US at about $80 billion and a trade surplus for China of $84 billion.

While a full trade war would harm China, the US would face some tough choices. I can hardly imagine the US suddenly looking for new suppliers for all the consumer goods it now imports from China. Chinese economists also point out that in case of a full recession in the US, Chinese exports would suffer less because a major part of the exports are low technology consumer goods.
Relations between the two powers are very complex and often plagued by mutual distrust, cultural differences and misunderstandings. In recent US opinion polls, Americans now regard China as unfriendly by 58% and as friendly by 28%. In another poll, one in four Americans holds "very negative attitudes" towards Americans of Chinese ancestry.
Americans also fail to see that anti-American sentiment is now having a life on its own among the younger Chinese generation, the same youngsters that surf the Internet, want to study in the US and eat at KFC.
We can only hope both China and the US will avoid political missteps and come to a more balanced relation.

Japan's economy

Japan and the US are China's biggest trade partners. China admits their economic slowdown will put continued pressure on China's exports. Japan is very important for Asia. It is not only the major economy but together with the US, it helped cushion the Asian crisis in the nineties. It is a major importer and investor. If Japan continues to spiral down, the influence on Asia will be serious.
I agree with some Japanese analysts that there is only one way out for Japan: a major cleanup with innumerous and devastating bankruptcies to unravel the tangled web in the economy, paving the way for the good companies to raise from the ashes. The result would be a painful short-term drop in growth and employment, followed by recovery and sustained growth. It could seriously affect Asia and could trigger a chain reaction.
Japan has tried everything it could to artificially revive the sickly economy. There is hope with the new Prime Minister Koizumi but it is not sure he can really shake up the establishment. Will he succeed to push banks to forgive about one trillion US$ in loans that are not being repaid?

"THE FUTURE OF FOREIGN INVESTMENT IN CHINA"

The BEIJING FOREIGN INVESTMENT SERVICE CENTER, BEIJING INTERNATIONAL INVESTMENT PROMOTION COUNCIL and BEIJING ASSOCIATION OF ENTERPRISES WITH FOREIGN INVESTMENT, under the Beijing Municipality, welcomed delegates of foreign organizations and companies to attend the half-day seminar in its meeting hall on the 3rd Floor of Building F, Fuhua Mansion.

Program - 19 June 2001, morning

Introduction of the speakers

Mr. Sun Chang Tai
Senior Economist, Director of Beijing Foreign Investment Service Center, President of the Beijing International Investment Promotion Council and Vice Standing President of the Beijing Association of Enterprises with Foreign Investment.

Mr. Zhang Xunhai
Presently Vice Director of the Foreign Investment Administration, MOFTEC.
Born in 1955 Mr. Zhang obtained his Doctor degree at the Economics Institute of Cambridge University.
He was formerly Vice Director of the Foreign Finance Administration of the People's Bank of China and Director of the International Department of China Insurance Regulatory Commission

Dr. Chen Gang
Presently Vice Director of the Beijing Foreign Trade And Economic Commission.
Born in 1964 Mr. Chen obtained his doctor degree at Beijing University and studied at the Kennedy Institute of Harvard University.
He was formerly the Vice Director of the Beijing Glass Institute and Vice General Manager of Beijing First Light Industry Group.

Lehman, Lee & Xu
Lehman, Lee & Xu is the fastest growing and most diversified intellectual property law firm in China, with offices in seven major cities including Beijing, Shanghai and Guangzhou. The firm has extensive experience in all aspects of intellectual property law, including litigation, prosecution, licensing and software registration, as well as counseling services for patents, trademarks, copyright, trade secrets and unfair competition. The firm also has significant experience in the areas of employment, franchising and general commercial law. Lehman, Lee & Xu is unique in that it is the only firm that provides nationwide services that has been approved by China's regulatory authorities to represent foreign applicants in filing and prosecuting patent and trademark applications. The firm is also unique in that it employs both foreign and national lawyers. Further information on the firm can be obtained from the website (www.chinalaw.cc).

Mr. Gilbert Van Kerckhove
Advisor of the Beijing Foreign Investment Service Center and the Beijing International Investment Promotion Council. He is the president of China Strategy Limited. He has been working with China since late 1980 and lived here for about 15 years. He is also Adviser to the Belgian Minister for Foreign Trade, advisor to the Jiading and Songjiang Industrial Zones in Shanghai. In 1999 he received the prestigious Magnolia Silver Award from the Shanghai Municipal Government.

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