The Issue of China

China Challenges Us

I've been talking a lot to colleagues over the last week about the visit of China's President Hu Jintao to the United States. This is happening critical moment in the relationship between the United States and China, for a lot of reasons. (An important aside: All the photos on this page are mine, and protected under copyright. Please email me for reuse permission. Thanks!)

First, the trade imbalance with China. It apparently indicates that we're buying Chinese goods at a 5 to 1 rate over what we export to them. That's a lot of cash going in their direction. Things are not quite what they seem, though. China has recently, correctly argued that half the goods sold to the US are actually the result of FDI -- much of it from the United States. So some companies in the US are actually successfully using China's economy to sell US consumers goods at presumably better value. But the trade deficit is real.

Second, China is marching towards full WTO membership. This means that its laws must be harmonized with WTO standards. Separate from a discussion about whether the WTO standards are good -- and even properly developed -- China has been taking stepwise movements towards harmonization that have been slower than what many Westerners would have liked.

Third, China uses up resources at an alarming rate, and they're using them up faster than ever. (Its economy grew at an annualized rate of 10 percent, according to the latest figures.)

OK, you know all this. But here's my take on each point.

1. Trade imbalance: This is an inevitable part of the Chinese-American economic dynamics and it will not disappear. Short-term fixes are just that. You can't make the dollar cheap enough to get currency parity.

China may wind up fully floating its currency (right now its exchange rate is tied to a basket of foreign currencies), but it will still have a billion people willing and able to work at wages we cannot compete with in the United States.

In fact, in some sectors, the trade balance will get worse. China has not been content to be merely a cheap manufacturing center. They've been pushing hard to do integrated products and I can tell you from my own experience that their ability to absorb management skills and develop markets and brands is stunning. They're positioning themselves to compete with fully developed Western economies on a full range of value-added product lines. Look for Lenovo to be offering more than computers in the next five years.

The consequence is that the issue is not the trade imbalance: it's what the trade imbalance portends. As global as US businesses are, it is not enough. And as worldly as US citizens might like to think we are, our culture is simply not prepared to deal with the social, economic and political consequences of China's emergence.

A friend who is a brilliant financial analyst and trader, Jason, laughed when I said to him on a recent trip to London that China is going to be a huge economic power in fifteen years, perhaps threatening US economic power. He countered that the size of the US economy was so huge, and it was so stable, that he doubted seriously that China would be so strong, relatively. Looking at the numbers, I think he's probably right that the US economy will still outstrip China's in that time-frame. But upon reflection, I think both he and I missed the point. The real tale will be told in the balance of economic power: China doesn't have to be equal in size to the US economically. It merely has to be powerful enough to change the buyer/seller relationship, currencies, money markets, and resource distribution. It's doing that already. And in an unstable world, such ongoing competition will amplify the effects we feel on commodity prices, fuel, labor pools ... it's a big deal!

Now, don't get me wrong. I love so much about China. I get to Asia whenever I can. The people there are impressively kind, ambitious, globally aware. Shanghai is breathtaking. And I love a lot about my own country. Separate from the love here, though, is the reality: Our trade imbalance is a symptom of much larger, economic issues that themselves inevitably will shift our world view.

2. WTO accession.

My wife and I were in China one morning, walking through a park in Shanghai full of people exercising. Groups of people in big knots, couples, even people all by themselves, were doing t'ai chi.

It suddenly hit me that this is a precise metaphor for how China is integrating into the world. China apparently has learned not to rush into changes that can cause social, political or economic pain. They put down a foot in a new place, shift their weight until they're confident of the next move.

And we're not just talking about legal and regulatory reform. Recently, Energizer Holdings (the Energizer Bunny folks), recently won a case against two dozen companies, including seven based in China and Hong Kong, who had been producing mercury-free batteries and exporting them to the United States. Energizer holds the patent on mercury-free batteries, and wanted to negotiate with the infringing companies to make sure Energizer was compensated for its intellectual property. The ITC, which oversees these international trade appeals, was addressing a defense by the Chinese companies that the patent was invalid.

How does this square with the press coverage from China? Keep in mind that much of the Chinese press is heavily influenced by the government. Here's what you can read online from ChinaDaily.com:

"'We saw this technology as common knowledge, rather than an invention belonging to a single company. Just like everyone knows people need four wheels to build a car, but none of the auto manufacturers actually have to pay for that knowledge,' says an official with China Battery Industry Association who declined to be named." The China Battery Industry Association is part of the China National Council of Light Industry, in effect a quasi-governmental organization.

China Daily continues: "The US Court of Appeals for the Federal Circuit rejected an appeal on battery patents by Energizer Holdings Inc against the US International Trade Commission (ITC). The ITC ruled in favour of nine battery makers from the Chinese mainland and Hong Kong over one of Energizer's patents in the United States in June 2004."

Contrast this with a press release that just came out from Energizer:

"The Court’s January 25, 2006 ruling, and a subsequent mandate issued on March 20, 2006, reversed an earlier ITC opinion and directed the Commission to proceed in accordance with the Administrative Law Judge's prior ruling that the Energizer patent is valid," according to the release. (I got a copy of the release from Levick Strategic Communications, who is working with Energizer Holdings to promote their ITC win. LSC works with a company for which I do strategy consulting. You can find Energizer's release here.)

In essence, the Energizer patent is still in play and can create a justification for ITC to halt battery imports from infringing companies. (Some previously infringing Japanese companies have paid Energizer fees to let them continue to manufacture and export their batteries.)

Energizer, I am told, takes the position that the Chinese press and the China Battery Industry Association probably misunderstood the real impact of the ITC ruling.

That's certainly possible. But by promoting a false victory, China's official organs and unofficial press outlets have created a perception problem for a major US company that was just trying to play by international IP rules. And perception affects shareholders. So the issue goes beyond protecting Energizer's marketshare. It goes to Energizer's value to the stock market.

Energizer ultimately has little to worry about. It's a solid company with a long-term vision for a cooperative role in China.

But this example has two fine points: First, to protect your IP requires money enough to not only do battle in the international bodies and US courts; it requires money enough to battle the Chinese press, which is far less independent than it should be, in my view. (It's getting better, we should acknowledge.) Energizer Holdings can afford this. But what about hundreds of thousands of other businesses engaged with China? Can they stand up to the looseness with which some Chinese companies respect IP law? Can they stand up to the press and the government-sponsored trade associations that (deliberately or not) protect infringing Chinese companies? It's a tough situation.

The second fine point is an irony. The Chinese companies that fought Energizer on the validity of its patent are themselves involved in submitting patent applications for their own technology. Why? China Daily again: "Nanfu Battery is the biggest battery manufacturer in China. Its profits had also been eroded by piracy."

I wonder if this fact represents an opportunity for Energizer, and for other global companies doing business in China. What if these companies allied with Chinese counterparts who were also suffering from piracy? After all, the ultimate problem is not China as a country. The ultimate problem is piracy.

Let's put a ribbon on the WTO/harmonization of laws point. We should cautiously optimistic about many of the announcements timed with the impending visit of the Chinese president. One report from China is that the government is setting up service centers in 50 cities focused on handling domestic complaints on the infringement of IP rights. The goal is to create in 2006 a "vertical IPR protection system from the central government to local governments at all levels." (Chinaview.cn, April 12, 2006). Looking deeper into this, we can see that the intention is to protect domestic companies from IP violations primarily, and secondarily to improve dialog and interaction with international players. (Click here to see more.)

This is not as self-centered as it sounds: Remember that a significant portion of China's exports come from companies receiving foreign direct investment (FDI), including from US-based companies. Thus, for example, this system should support any joint ventures between US companies and Chinese entities. And, in my view, it places the battle where it should be. This is a not a US vs China discussion. This is a rule of law vs piracy discussion.

The Secretary Gutierrez said it right this past March: "[A key element is] transparency and predictability in the rule of law. Businesspeople like to have predictability. It's OK that things are risky as long as we know what the environment is going to be. Business people take big risks, and business people invest a lot of capital. But what they want is to know what the rules are going to be five years from now or ten years from now, so that they understand how to play the game."

The reason for caution, however, is that this plan will take three years to roll out. (Click here to see more.) The message to the West might appear to be: We're taking IP seriously. The message to their own companies might appear to be: You've got three years to clean up your act, so in the meantime, have at it. In short, China's government may be creating a climate that encourages its domestic companies to reform slowly.

3. Finally, as for China's increasing use of natural resources: I say, we must be vigilant against hypocrisy. The United States is by far the hungriest of countries. We need a global commitment to better management of our resources, and severe sticks combined with enticing carrots to get corporate and consumer behavior to line up around our environmental and strategic needs. Unfortunately for US conservatives who hate big government, we are far past the point when pure market options will deliver for us. Of course, we must be clever about creating market-driven options (some of which were rejected by the current administration right after they came to power). They will help. But for the sake of our country and the world, we all must dig in, now, to slow down our rapacious appetite for raw materials, to manage them better, and to make our planet fit for future generations.

I gave a talk to a bunch of bright Cornell students last summer on the nature of social networks, the Web and how that is changing our culture. When I was growing up, I said, I knew one Chinese woman, whose family had moved to my little town in Virginia. I certainly didn't correspond with any Chinese people. I asked the students, "How many of you know someone from China?" More than three-quarters of the students raised their hands. Then I asked, "How many of you regularly communicate with someone currently IN China?"

About half the students raised their hands.

It's a new, connected world. It won't look like the world those of us over 40 grew up in. It's not just a global economy, it's a global consciousness, a global network. And I, for one, think that this network will more easily tolerate trade imbalances than they will accept poisoned air, famine, and depletion of irreplaceable natural resources.

I think the moment I spent with my wife in the park in Shanghai in which the T'ai Chi model of Chinese progress occurred to me has given me a new insight into Western ways. The Washington Consensus embodied in organizations such as the WTO is all about running headlong towards free trade and open markets. In that park, filled with ponds and curved pathways, trees, bushes, flowers and a merry-go-round, surrounded by gleaming modern office buildings and red construction cranes, I didn't see any runners. China may appear in some ways to be embracing free trade and open markets, but they're not racing to be just like the West. They have a more measured plan.

This should perhaps inspire us all to have a better, measured plan, created by all our key trading partners: Let's build a world we'd want to leave to our children. Rule of law matters, but not just for aiding free trade. It's a matter of fairness. And we're being unfair to future generations if we blindly pursue growth.

Let us not criticize China for its resource hunger. Let us all take the blame and find the solution together.