I once heard a sporting goods salesman explain the
technology of their new composite wrapped baseball bat. “You get more distance
relative to other bats. More distance equals more home runs.” I know they test
these things so I pressed a little. “Does it really work that much better than
other high end bats?” He looked a little confused “Um...It should.” It reminds
me of how the business community thought of China’s growing economy over 20 years ago. Many thought the country could be ‘turned’ into a free market
capitalist society. Based on foreign investment and market reforms it seemed to
some that “It should.”
Turns out that reality is more complicated and what a lot of
corporate types hoped would happen, didn’t.
Early last week China’s
president Xi Jinping announced that he was ‘changing’ the constitution so as to
serve unlimited terms as the leader. Previous presidents served two terms of 5
years each. It’s doubtful that any constitution had law binding capabilities
that would be upheld by the Communist Party. But in the late nineties the State
Department and a lot of CEOs believed that a growing market economy in China
would force a softening toward the West. If the Chinese could become consumers
and build a middle class they would insist on democratic reforms and more
freedoms like Hong Kong, it was thought.
How realistic was it to assume that with a little prosperity
and lower trade barriers, China could transition from the closed world of
protectionism to a free market nation? Depends who you ask but the idea was pervasive.
Right now though it seems foolish to assume an authoritarian government would relinquish
any control, whether financial or cultural. In order to understand why smart
people thought this way we have to understand the time.
During the late nineties the Communist Party began
experimenting with privatization and banking reform. Led by Deng Xiaoping,
reforms in certain industries like agriculture began turning a failing sector
into a secure and profitable enterprise. They encouraged foreign investment and
deregulated much of the economy. The poor nation needed money so it looked to
the West. It was limited in scope and most of the really profitable industries
(energy, manufacturing) remained state owned. But the reforms worked and
created a sense, among some, that the one party state was opening up to the
rest of world.
Two big events happened after that. First the British began
handing back Hong Kong to Beijing with certain exceptions. Hong Kong would
retain the ability to govern itself, keep its valuable currency and operate in
a free economic zone apart from Beijing’s interference. The Brits had operated Hong
Kong as a territory and set it up as a free trade zone after ceding control.
Hong Kong had been separate from China before.
Second, the United States and
other Western partners admitted China into the WTO (World Trade Organization)
if they met certain benchmarks, mainly they had to make their economy open to
foreign business and ensure self-governance. Also China agreed to abide by the
rules of trade for members of the WTO. Rules on tariffs and quotas have to be
voted on by members and international courts preside over disputes among member
countries. It’s worth noting that the PRC (People’ Republic of China) did make
some drastic moves at home (at least superficially) to show their commitment to
joining the club. In 2001 they were admitted as a full member and the mainland
economy grew exponentially.
The internet was seen as a positive development that could
bring democratization to Chinese citizens and introduce them to new ideas and,
hopefully, Western thought. This wasn’t completely naive. When people are
connected across vast swaths of the country leaders are held to account for bad
behavior. But the Chinese were never going to let any new technology into the
country until they had a way to control it. They periodically blocked news
websites like the BBC and Bloomberg for various reasons. Certain words or
phrases like “democracy” or “Falun Gong” (a religious group) would not return
any results with a Google search. The censors blocked countless websites viewed
as subversive. Arrests and detentions of journalists and Christians still
happened but less so, since more the government needed to appear conciliatory. If
not conciliatory at least they understood the importance of hiding the uglier aspects
of a police state. The economy was growing so well no one wanted
to slow it down and hold Beijing accountable for obvious infractions. Neither
did the Chinese government want to rock the diplomatic boat over some display
of police brutality or arrest of a prominent journalist. China didn’t change
dramatically in the 2000s but did learn to hide a lot their moves.
American businesses that entered the market mostly became
frustrated by the lack of cooperation and intellectual property theft that is
as common as the cities’ smog.
Intellectual property theft is more serious than people
realize. If patents aren’t respected in foreign countries companies can’t sell
product and demand the same value. It works like this, if Nike designs a
running shoe for sale in retail stores around the world they expect to be the only
ones making that shoe. Chinese factory owners frequently copy the design to sell to
their own venders. DVDs create the same problem, as do software and tools and
anything that carries a patent. Knock off copies of nearly everything exist
within the country because the law doesn’t effectively crack down on theft. The
authorities do some token sweeps of sellers from time to time but it doesn’t
amount to deterrence. I once asked a Chinese business man why the authorities
don’t enforce the law. “Why should they? The factories that make the fakes
create thousands of jobs for unemployed workers and shoppers like cheap options.
From a Communist official’s point of view, it doesn’t make sense to curb it.”
Another aspect of opening a Chinese branch of your particular
business is the ‘shared’ aspect of making money in the country. Big companies
like Yum Brands (Pizza Hut, KFC) have to partner with a Chinese local company
and share profits in order to open a location. This creates friction when the
regulations change and rules aren’t clear. Having a partner means sharing
financial information and intellectual property. Not every foreign company is
doing poorly but the trend is toward less control in decision making.
I’ve wondered how much of the optimism toward China was genuine
and rooted in positive changes the government was making, and how much purely
driven by new markets. When the opportunity to make money presents itself you
take it. Did American shareholders really believe that China was on the cusp of
a global opening for democratic norms, or did they just pretend to in order to
expand. The old saying about business is that if you aren’t growing you’re
dying. What better opportunity to grow than in a country with 1.6 billion
consumers? Like my baseball bat salesman, something tells they didn’t really
know but figured “it should” work.
Since 2012 the Communist Party has started reverting back to
old tactics, crushing dissent and purging the ranks of powerful cadres. The first
big move Xi Jinping made was to start a ‘corruption drive’ to weed out bent
officials and purify the party. It turned into a ploy aimed at removing rivals.
Not that party corruption wasn’t a problem, citizens are all too aware of it,
but it served a larger purpose for the young president, eliminate competition
and send a message. Since then he has taken a wide swath of leadership
positions and chairs that other presidents never assumed. He has tightened the
noose of internet censorship and built up military bases along the South China
Sea. The military buildup in particular is a direct affront to the US which
patrols the region under a freedom of the seas initiative. Freedom of the seas
ensures rights to travel through the ungoverned parts of the ocean. Building
bases on shoals and tiny islands threatens this concept for both commercial and
US Navy ships. Almost weekly we hear of Vietnamese and Philippine fishing
vessels turned around, told to leave the area.
The US is in a tough position now. We have to determine what
is important to national security first, economic considerations should be second.
We should have learned by now that as long as the Communist Party is running
the show, open markets and liberal reforms are a nonstarter or at least very
limited. Keeping the South China Sea open for commerce is essential. America's Navy
should double its presence in the waters as a show of force. If the Chinese
restrict movement and dominate the sea our influence in the entire region is
over. Conflict is almost certain in the future. It doesn’t have to lead to a
full scale war, but our objectives on clear shipping lanes should be enforced.
Better an economic war than a military one. Hopefully is doesn’t come to that.
Our optimistic notions of China a bastion of free trade was always a pipe
dream.
Whether we really believed it or not is a mystery.
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