Having a China Dream with Joe Studwell

ChainLink: Joe, please tell us a little about yourself.

Joe: Born in England, lived in Hong Kong, Beijing (8 yrs), and I live in Italy now. I travel back and forth to China.

ChainLink: Do you still contribute to the Economist?

Joe: I haven’t written for the Economist or the Economist Intelligence Unit since 1999, though I’m sure I probably will again at some point.

ChainLink: What made you write China Dream?

Joe: After eight years living in mainland China, I wanted to figure out what I really believed about the place.

ChainLink: What made you start the China Economic Quarterly?

Joe: I thought there was a niche for a very high quality journal about the Chinese economy and investment in that economy and I wanted to fill it.

ChainLink: From the beginning of global trade, business people have dreamed of tapping into perceived large markets. Yet both China and India have been elusive. The gold rush is on, yet you are skeptical?

Joe: I’m skeptical about businessmen who think that an economy, which is only the size of those of Spain and the Netherlands combined is going to provide exponential demand for their products and services. I’m enthusiastic about businessmen who want to sell opportunistically to China (as you would to any emerging market) and source cheap manufactured goods from the place.

ChainLink: Joe, you talk about China’s two economies: the so-called public government owned sectors and the private enterprise. Can you talk about what these are?

Joe: The government still controls at least half of all economic activity in China. State companies dominate in construction, heavy industry and services—like telecoms and finance. Doing business with the state is difficult, bureaucratic, time-consuming and subject to huge swings in demand. It’s tough to win in this area. On the other hand, the emerging domestic private economy and the export processing economies are highly competitive and profit-driven, while demand is much less volatile. This is where it makes sense to do business.

ChainLink: How is a businessperson to sort out who/what he is dealing with in these two economies?

Joe: You have to constantly ask where the money is coming from in any particular business—from public or private demand. It’s not that difficult to do if you apply common sense. What you must not do is wander around the place wide-eyed, mesmerized by construction activity that is paid for through a nationalized and insolvent banking system. To think only with your eyes in China will not tell you where real, profitable business activity is.

ChainLink: I like the fact that you have significant focus on the trials and tribulations of starting a business in the China market. I asked Richard Chenevix-Trench^[1] about these investments gone sour and some firms leaving China. His comment was, that it just takes time—lots of time. My rebuttal was, "So, that should be considered a market research investment?^[2]" . He agreed. Do you see companies staying the course, or will more throw in the towel on trying to crack this market?

Joe: It’s a very difficult market and so it takes more time to fathom than most. On top of this, the domestic market is exaggerated in most people’s minds, so it’s unusually competitive. But capitalism never gives up; it just keeps trying. Right now, foreign companies in China are doing better than ever. This isn’t to say they are meeting their original expectations, but performance is improving—from a very low base. The Chinese government is helping out with a relentless deficit spending campaign that began in the wake of the Asian financial crisis and means there’s lots of extra cash sloshing about. I suspect foreign companies’ performance in the domestic market will continue to improve for several more years, right up to the point where China can no longer head off a horrendous financial crisis. At that point, the local market won’t look too pretty.

ChainLink: One thing you talk about, which kind of alarmed me, is the lack of central control in the Chinese government. With the fall of totalitarianism and the rise of the provincial wheeler-dealer environment in China, is this cause for concern, or good news for firms trying to operate in this environment?

Joe: There’s no shortage of control in China, it’s just unpredictable who is exercising it from one moment to the next—central government or provincial chiefs or village gauleiters. The political system has not been reformed one bit since 1979, so with all these new social and economic pressures playing on it, it is very creaky, very spluttery, very difficult for the businessman to figure out. The best thing is to operate in a business where you can avoid the politics.

ChainLink: From a supply source (components and other manufacturing capabilities), I guess the future there is basically a low risk issue? Costs are so low, and discipline high, it becomes very difficult for contract manufacturers in other parts of the world to compete. Are there supply risks that you think we should be concerned about?

Joe: I think supply risks are pretty low. Currency risk is negligible because the exporters earn foreign currency and so won’t be bothered by problems in the domestic financial system down the road. Labour unrest risk is rising a little, but in my experience young Chinese women, for instance, think that working on a production line is a dream compared to a life of cashless misery tending fields in the countryside. Logistical risk is low because export processing is coastal, and there are loads and loads of functioning mainland container ports these days. Of course it is wrong to assume China will make “everything.” At the bottom end, activity like shoemaking has already migrated away to a significant extent to Vietnam and Bangladesh. China is taking over a lot of stuff from richer Southeast Asian nations, but there are plenty of areas where China does not compete so well. China is not, for instance, hollowing out the semiconductor industry in the Philippines (which is instead a huge supplier to China) or the software services industry in India.

ChainLink: Many of ChainLink’s customers have big Intellectual Property problems as well as outbound trade issues (border crossing regulations, etc.) Do you see the Chinese getting their act together on this?

Joe: I think the Chinese government will get tougher on IPR infringements as they affect more Chinese companies, which is beginning to happen. But it will be very slow. I also think the IPR issue is mainly an issue of counterfeit exports. In the domestic market, it’s just not true to say that every Chinese who buys fake Microsoft software or a fake Gucci handbag would or could shell out for the real thing if piracy was eradicated. This is a poor country—US$1,000 GDP per capita. So when you hear that hundreds of millions of dollars of Viagra sales are being lost because there are 50 fakes on the market, you should take it with a pinch of salt.

ChainLink: Chinese are big savers—verses Americans. I assume their savings are helping to fuel the investments in these growing firms, like the Japanese did. Would China, though, wind up with a crisis like Japan once they have a convertible currency, which will lead to inflation?

Joe: Chinese people’s savings, gobbled up and lent out by the nationalized banking system, are paying for all those fancy high-rises. There won’t be a convertible currency prior to a financial crisis because it would expose the bankruptcy of the current financial system. So, all those American politicians who are calling for one because (in the short term) the renminbi is undervalued, are wasting their time. But I guess they have to campaign about something—there’s an election due.

ChainLink: Joe, this is fascinating stuff! Do you have some advice, words of wisdom to our readership? (Readers are composed of software firms, SC exec’s—both manufacturing and logistics, US Department of Defense Logistics, some financial investors, and my mother, of course!)

Joe: Common sense. In general, there’s a correlation between big multinationals in China with big dreams and “visionary” CEOs and losing money, versus smaller foreign entrants that can’t afford to waste cash that turn out successful. It’s a place where you have to roll up your sleeves and get very involved. That means finding the best possible local managers and then trusting them to get on with the job. Oh—and don’t accept different standards in China. You are there to make a profit, just like everywhere else, not to listen to some guff about x thousand years of history. Remember what the guy in the movie kept saying to Tom Cruise and you’ll be ok: “Show me the money!”

ChainLink: Joe, Grazie! Xièxie! Merci! Dhanyavaad!

[1] Hedge Fund manager at Sloane Robison Management

[2] $2B plus for GM is a pretty big market research investment!

©2003 ChainLink Research, Inc.