George Zhibin Gu, Ph.D.
"Ahead of the Trend"
Transcription of Audio Interview, January 14, 2006
JIM PUPLAVA: My guest this week is George Gu. George obtained his education at Nanjing University in China and Vanderbilt University and the University of Michigan in the United States, he holds two MS degrees and a PhD from the University of Michigan. Since 1990 he’s been an investment banker and a business consultant. He’s also worked for the last 15 years in the investment world with a focus on China. His work focuses on helping international businesses to invest in China and Chinese companies expand overseas. He’s got experience working with Prudential Securities, Lazard and State Street Bank. He’s also written several books, one Made In China: Players and Challenges in the 21st Century, and his current book is called China’s Global Reach: Markets, Multinationals and Globalization.
George, you grew up in China during a very difficult time, especially during the Cultural Revolution. How has this impacted your thinking today in terms of how you view China?
GEORGE ZHIBIN GU, PHD: Well, while I was growing up in China, China experienced a cultural revolution, as well as people’s communes in the countryside. It was chaotic, it was characterized by abusive government power which was expanding into everybody’s lives. What is more, it was an entirely closed society. In other words, every citizen had to work for the government to make a living. So the government exactly demanded the servitude of citizens, but today everything has changed fundamentally. So, in my mind two things are most crucial for modern society and progress, that is, having an open society is a must; secondly, private initiatives - people must rely upon their own efforts for progress and prosperity. That is exactly what has been happening for the last 25 years. This makes all the difference. The third one is that international participation in any country’s development is a necessity, otherwise development slows down tremendously. So, the situation in China and India shows [this is] the case. [3:05]
JIM: You know that was one of the points that you made in your book, that the grand lesson of China is that no nation can truly develop without making itself open to the rest of the world.
GEORGE: That is very true. 500 years ago, Europe became an open society expanding globally. Especially the US, it depended on talents, capital, and technology from the rest of the world. That’s why the US has become a dominating power globally for the last 100 years. Today, China is doing the same thing, relying upon all the resources from around the globe. [3:46]
JIM: You know, one of the great paradoxes as you look at China today is this vast economic progress, but it does not have a new political-economic system in place. Can you explain that?
GEORGE: Basically, this current reform at an institutional level was initiated by the government. The government wanted to try something different from the previous 30 years. In Mao’s era the government dominated all economic and political spheres - everybody had to work for the government. On the other hand this political structure created a lot of burdens for the government. Therefore the government wanted to shift the burdensome aspects of the business to the society and people. At the same time, government does not like to give up on its traditional power hold on the society, therefore at the institutional level you [will] still see that traditional political framework is still at work. For example, about 70% of China’s business assets are still in government hands. So, this is one fundamental aspect of China’s current reform. However, you see the other trend which is overpowering the government and promoting its political and economic reform, reluctantly or not. [5:24]
JIM: George, in your mind what are the key driving forces behind China’s economic development today?
GEORGE: Number one, opening up. During the Cultural Revolution, China’s economy was shutdown. It had no economic ties to the outside world whatsoever. So, opening up China has brought new ideas � technical and technology � as well as results, for growth. So, this is the most crucial aspect behind the growth.
Number two is the domestic consumption explosion. For example, 25 years ago China did not have any mobile phones, but today China has about 400 million mobile phone subscribers. Also, 20 years ago China had few television sets, but today almost every urban family has at least one television set, and in the countryside about 50% do. So, therefore China has become the biggest home appliances market really.
Number three is international involvement in 3 areas. The first area is foreign direct investment (FDI). In the last 26 years China has received more than 600 billion US dollars in FDI. This FDI has prompted new growth, especially in the manufacturing area. Number three is international trade. So far, China’s international trade has grown tremendously from next to nothing 25 years ago to one of the top three trading nations today. So, this international trade is another area of growth, but overall the domestic consumption explosion is the foundation. Without it China could not attract foreign capital or international trade. [7:33]
JIM: Now, you state in your book one of the ultimate goals for your country is to become a modern nation ruled by law.
GEORGE: That is true.
JIM: How does that happen given the government structure you have today?
GEORGE: It’s actually slowly changing. The government has found out that it does not need to apply traditional power to rule over society. Actually, being without the law also brings burdens to the government. For example, in the economic field there are all kinds of disputes among different interest[ed] parties, therefore to resolve such disputes they must apply law, legal procedures in a new way. Therefore we have a lot of legal progress in the economic and business field. Even in the political sphere some new political measures have been introduced. For example, direct vote at the village level has been introduced. That is, at the village level the village leaders are directly elected by their villagers � that’s a new change. And if this trend grows you will see more political changes, especially in the legal and power structure. [8:56]
JIM: Most people would be surprised, even though China is referred to as a developing nation, throughout most of history China has been more advanced in technology, the arts, and social harmony. I wonder if you would give us a little historical background of just exactly how developed China was. I think most people would be really surprised.
GEORGE: For example, about 150 years ago China was the most advanced nation in terms of wealth. At that time, China contributed about 30% of world economic output. 1000 years ago China already had 50 of the biggest cities on a global basis. The biggest city in China at that time was Xian, which already at that time had a population of about 3 million. Also, about 50,000 foreign nationals lived in the city, mostly from Japan, Korea, and the Middle East. Xian was the beginning point for the Silk Road, international trade had Xian as its center. This was about 1000 years ago. [10:27]
JIM: You know, the old China was based around government and agriculture. You’re moving away from that, especially away from government domination. But, you know, the one thing that seems to me that China does, which you don’t see too much, when you think of planning in the future, your government and people there tend to think in decades. Is that how you see this unfolding, it’s something that’s going to take decades before we see a completely open market, a completely open financial system, and less government dominance?
GEORGE: It’s happening faster than previously thought. For example, even now, international banks are allowed to buy major stakes in Chinese banks. Therefore we have seen a couple of big transactions already happen: one is Bank of America; another is HSBC buying serious stakes in the top five Chinese banks. This has prompted what I would call a revolution in the Chinese banking system. That is, not only is international capital injected into Chinese banks, but also a lot of managers � we’re talking hundreds of international managers appointed by Bank of America and HSBC � managing Chinese banks on a daily basis. That’s a huge change.
Also, another tremendous change is the emergence of 40 million private entrepreneurs. 25 years ago it was a completely state sector, now we are talking about the state sector retreating to about 50% or less in terms of economic output. The state sector now only contributes about 30%, the rest is from the private sector and the international sector. In terms of industrial output, 2 years ago, International Inc. � as a group � contributed about 31%. That’s a huge market share, we’re talking about a 1/3 market share. So, this international presence, as well as the private sector in China, are altering the Chinese political and economic map � that’s something nobody expected before. [12:56]
JIM: It’s rather ironic as the West moves to more government control, and less freedom, China is moving in the opposite direction.
GEORGE: Right now, China is quickly adopting international practice and standards in all kinds of ways. The only problem is this old government structure which still tries to dominate in the traditional sense. So, institutional progress is [slow]. Other than that the society, the business community and international parties are changing the Chinese traditional life in big ways. So, that is happening really in big ways here. For example, in coastal China in many regions such as Zhejian province, and Jiangsu province neighboring Shanghai, the private sector takes over up to 70% of the local economies. So, government power is [receding] tremendously. [14:06]
JIM: Now, in your book you talk about what makes a lot of this possible today is the emergence of multinationals, which you describe as the modern-day Columbus’ and Magellans. And China, to the multinational company is really the world’s last frontier.
GEORGE: That is true. Right now, we have basically everybody in China from the multinational group. They are active in all aspects of the business sphere, especially autos. They dominate China’s auto market. They are also major players in the mobile phone business, in high tech, in semiconductors. For example, right now, about 20% of the global semiconductor market is in China. So, regardless of which US semiconductor shares you hold, you are investing in China already because 20% of the sales are to China. [15:13]
JIM: George, what makes China attractive to multinationals?
GEORGE: Basically, there are several reasons. Number one, there is tremendous consumption growth, also better profit margins. Number three, there is a relaxed business environment and sometimes in very odd ways. For example, China does not have Western type labor unions, so employers have plenty of choices in terms of their power over their employee body. And employees don’t have any bargaining chips. That is also a factor. Another factor is the many incentives given by the government such as tax incentives and other privileges. And number three is quick growth for the multinationals which are already playing here, therefore they force their competition to come. For example, all the telecom manufacturing operators are in China. Last year, Nokia did about US$6.9 billion in business in China; FedEx did even more, about $9 billion in sales in China. Then you also have a lot of other guys � their competition � also the new players coming in, especially in high tech. Therefore, all of them have become the most significant players in China. They have to be here, because right now up to 30% of their sales come from China, directly or indirectly. [17:06]
JIM: Now, in May of 2003 the Chinese government allowed 2 investment banks, Nomura and UBS to trade in the Chinese stock market. George is this a sign of things to come, and initially why only two companies?
GEORGE: Basically, the Chinese government has a law qualifying foreign institutional investors to play in the domestic market. Initially, they gave about a US$4 billion allowance and you have to go through the selection process. So, in order to attract competition from foreign money managers so every month they gave permits to a couple of players, that’s how Nomura and UBS got the first tickets, but we’re seeing during the last year and a half about 27 UBS competitors such as Morgan Stanley, Goldman Sachs and JP Morgan all got [permission]. So far, they have invested about $4 billion, now they’re putting an additional $6 billion (US) into China’s domestic stock market. So, that’s what’s happening. [18:26]
JIM: I wonder if you might explain how the development of China has become the global manufacturing center has been more of, let’s say, a move by demand than by design.
GEORGE: Yes, that is one of the biggest Chinese growth stories, and nobody expected this to happen 25 years ago. It has come to life more by accident than by design. The initial stage was really a shift to meeting consumer demand for home appliances and electronics. At that time China did not have anything to manufacture on its own. It shared a lot of TV sets from Europe, Japan, and South Korea directly. But those TV sets had high price tags on them. You’re talking about the average Chinese family having to spend up to 10 years of their savings to buy a TV set. This huge profit margin prompted tremendous domestic investment. Immediately, we’re talking about several hundred Chinese TV manufacturers emerging by the mid 1980s. The same thing can be said of other areas of consumer products. The demand was tremendous, that’s because for most of the time China had a tremendous goods shortage for about 3 decades. There was nothing on the shelves. If you wanted to buy a pair of shoes you might have to wait or if you bought a bicycle you needed to find a friend to help you get one. So, there was a tremendous shortage meeting this huge consumer demand which therefore gave birth to the initial setting up of new manufacturing. Once this new manufacturing was set up, then they had to buy all sorts of components and chips. At that time, China couldn’t manufacture them itself, therefore it had to buy them from the overseas market, such as from Intel, Texas Instruments, and IBM, and Motorola. Therefore those international multinationals made huge profits sending their components and chips to China. Later they found out that they had better set up manufacturing facilities within China in order to make better profits. That’s initially how they came 25 years ago. So they were brought by the tremendous profit picture, and immediate business transactions.
Later on, Intel and Texas Instruments’ competition all rushed in. The same thing is true for all other economic sectors. So competition brought more and more multinationals to China. Of course, these multinationals have more economic muscle, they can manufacture almost anything, therefore they have helped to directly expand the growth of China as a manufacturing center. Later on, the Chinese [had] learned a lot from these multinationals, they started manufacturing key components and software and also chips. So, more competition was arriving from every party, but the market is still expanding, therefore the bigger pie is attracting more players to rush in. Therefore we see the emergence of China as a manufacturing center.
We’re also talking about other areas of improvement to facilitate this growth as a manufacturing center. Number one is infrastructure. So, China has become the number two energy market on a global basis. It has built the most power stations over the last 25 years, also roads, ports, as well as the service sector. For example, all the major global shipping companies and express companies are all in China. For example, Federal Express, UPS, and all their competitors are in China. Therefore, China through all such activities has gained all the key elements to build a major global manufacturing center. It came as an accident but by now, it has brought on a rush by everyone else behind. So we might expect a quicker development for services to add to this new manufacturing center. At this time, this manufacturing center is able to produce at low cost as well as efficiently almost all sorts of products, this is the biggest change for China’s economy, as well as for the global economy. [23:50]
JIM: George, there are other places in the world where the labor pool is much cheaper. For example, India and there are other countries. Is it China’s sense of business or its entrepreneurial shift which distinguishes China from the other places in the world?
GEORGE: Yes, I would say that it’s China’s overall strength that makes China a new business center. If you compare India and China you will see that India’s labor market is cheaper � about 50% cheaper � than China’s. But India’s development is more in the service sector, especially for software consulting and outsourcing. But China’s manufacturing [has advantages over the] Indian one in many aspects. This is because China has built up a complete business chain, for example, India does not have an effective manufacturing base at all. It lacks key component suppliers, it does not have the logistics, it does not have the infrastructure, but China, over the last 26 years has gotten all of them in one place. For example, in consumer electronics you can set up your shop in Guangdong, then you get more than 10,000 component makers. For example, Sony alone has more than [3,000] China based component makers. Here, you need to know that these component makers come from both Chinese companies and multinationals. So, Sony’s 3,000 come from the Chinese, the Japanese, Koreans and Europeans, and American suppliers, always in China - actually, in one province. That’s the kind of effectiveness and efficiency China has, but in India, and even in Europe you don’t have that kind of advantage.
Another advantage is the low price [gap]. These companies rely on cheap labor as well as mass production which can give you the best price, and also delivery at the best time, or any time. Therefore it gives Chinese manufacturing a lot of advantages. This is something India, and many other countries, don’t have. To build up this we are talking maybe about a trillion dollar investment plus all the key players - we’re talking about tens of thousands there from all business sectors. That’s difficult to attract all the elements into one place, within such a short time. Therefore, I call this Chinese manufacturing center an accident rather design. But it is now entering a new phase - with a lot of powerful players and a lot of design coming into play. [27:06]
JIM: You believe one of the biggest driving forces behind China is consumption. You had mentioned earlier there’s close to what, 400 million phones in China? And if you look at China now, a lot more people have the means to buy a car. Talk about this consumption because even though consumption is increasing in China, your country is also known for its savings rate.
GEORGE: That is true. Several factors contribute to the high savings rate in China. Number one is that China does not have a safety net as in the US. In the US, the savings rate is flat, people depend more on pension insurance and social safety net, but in China those things aren’t widespread, therefore individuals and families must save for rainy days. And this naturally produces a high savings rate. We’re talking about people saving about 40% of their income on an annual base. Therefore, the banks have helped with this high savings rate. We’re talking about an average annual growth of about 10-12% in banking deposits. So, this huge [quantity of] new money keeps pumping into the Chinese economy. That’s another strength that China has: there’s plenty of capital. I would say that at this time that China has more capital than it really needs, therefore it should really invest this capital back into other nations such as the US, Europe and developing nations as well. [28:48]
JIM: Taking a look at some of the experiences China has as a culture, talk about the entrepreneurial spirit in China, because certainly that is something that distinguishes China versus let’s say Japan and other countries. In other words, the Chinese are more willing to take risks than say other countries, as a culture.
GEORGE: Yes, that’s a fortune for the Chinese civilization, after the Cultural Revolution China’s industry was very much bankrupt, China’s economy was bankrupt, and China had general poverty. Also, hunger was widespread, especially in the countryside. Everything was desperate. But China also had one thing which was not destroyed by the Cultural Revolution: that is, family values and entrepreneurship. Immediately, hungry individuals and ambitious citizens [started] setting up their own businesses, shops, trading and manufacturing companies. All sorts of industries emerged immediately. So, this private entrepreneurship is still a driving force in Chinese society, but what’s more important is the desire to get out of poverty, relying on one’s own efforts. So, in all regions of China we’ve seen new shops set up by families. So far, we have about 40 million new entrepreneurs playing.
The growth of this private sector is most significant in China’s economic growth because it means that a new business model has developed. A lot of rural towns now have become specialized industrial towns. For example, one town in Zhejiang province has become a top manufacturing center for toys, another town for furniture, a third town for clothing. So this kind of specialization is also another kind of phenomena for China’s family businesses. This family business growth is also different from the US. In the US family business grew naturally, but in China it grew against a harsh political background and also a pitiful history, therefore it demanded more struggle. Also the Chinese private sector did not have any capital, the entrepreneurs had to sell their furniture, had to sell their private belongings, or borrow from family and friends and neighbors to raise the initial capital. Now we’re talking about the private sector contributing about up to 35% of China’s economic output, and about 25% of employment in urban China, that’s a tremendous change. [32:13]
JIM: You know, I wonder if you might contrast � since you do a lot of work helping companies to do business in China as well as Chinese companies expand abroad � and talk about what has been successful for foreign companies that have come to China. What they did right versus those that have failed and what they did wrong. I’m thinking of let’s say Volkswagen versus Ericsson.
GEORGE: Volkswagen came at the right time, the Germans were good at details. At that time �we’re talking about 21 years ago - the Chinese bureaucracy was very troublesome, but the Germans through their patience learned the process of how to play with the Chinese government, how to make the most of the marketplace, and how to manage their Chinese employees. They were extremely successful. As a result by the late 1980s they became the name for auto manufacturing in China. All the Chinese taxis, Chinese company cars, even government cars were made by Volkswagen at that time. So it was tremendously successful. This success comes from several factors. Number one, a long term commitment, that is Germans want to grow [in] China as China grows. Number two, they had a very responsive management style, that is, it is ready to handle anything that comes up that blocks their progress. Number 3 is their effectiveness in managing Chinese employees, that’s also a key. Many international companies have not been as successful because of a failure in managing Chinese employees.
For Ericsson, that’s another story. It had early, quick success in the Chinese mobile phone market, but it could not improve fast enough, especially from the competition. For example, we’re talking about in the mid-1990s Ericsson was the dominant player in China’s mobile phone market, way ahead of Motorola and Nokia, but by the late 1990s it became next to nobody in the marketplace. Instead Motorola and Nokia took the top place. What happened? Number one, Ericsson could not develop new products effectively and deliver them to consumer hands efficiently. Number two, Ericcson had management problems especially on the quality side, its products had some defects inside them, but they were slow to correct them. And therefore they brought [upon themselves] a lot of consumer dissatisfaction and court actions against its defective products. Number 3, there was management chaos. Ericcson had problems managing its multilayer marketing and distribution network. A lot of marketing and distribution network channels were controlled by parties outside Ericcson’s control. The last factor is that Ericcson could not provide effective leadership. Its leaders were slow to respond to the changing marketplace. It could not correct their mistakes effectively. Therefore it became a loser for several years. But within the last 2 years, Ericcson has returned to the center stage by correcting all these mistakes. So, for the last 2 years Ericcson has retaken the number 4 top spot in China’s mobile phone market. Basically, it has been able to correct all of its previous mistakes. This is partly through its joint venture with Sony. So, Ericcson is doing much better today than 5 years ago. [36:34]
JIM: You know one thing that surprised me in your book is you were talking about Chinese college graduates today. Their top ten choices for employment, six out of ten were foreign companies, many of them American from IBM to Microsoft, GE, Motorola, and Procter & Gamble. Why is that?
GEORGE: In general, Chinese college graduates as well as employees prefer American employers. There are all kinds of reasons. Number one, American organizations are able to provide them with a good working environment, with maybe slightly better pay, and better promotion prospects. The best thing Chinese employees like about American employers is it is a very open and progressive working environment. That is, American managers want to promote based on merit, and merit alone. Therefore Chinese employees often can get to the top management positions within a country territory. For example, most American multinationals operating in China have Chinese � either domestic Chinese, or returning Chinese � serving at the top: for example, CEO, Chairman, Executive President of Board of Directors. So, the daily management is heavily handled by the Chinese themselves on behalf of American multinationals. This is one aspect of American management style and culture: this localization. In this aspect most of the companies are doing better than the Japanese and Koreans, and also the Europeans. That’s why Chinese employees’ number one choice is to work for American corporations. [38:31]
JIM: I want to talk about China’s impact on global pricing. We’re in a global market which tends towards lower prices for products as more services and companies have to compete. You talk about how even Microsoft was forced to price its Office products on a competitive basis in China. Explain China’s role on what many would call a deflationary impact on the globe.
GEORGE: This is [not] a new phenomenon. Basically, it has happened throughout history. For example, 100 years ago Britain was the number one industrial leader globally, but afterwards the US took over by having better products at lower prices. That’s exactly what happened, for example, the British produced the most luxurious cars but Ford produced the cheapest cars selling to the marketplace. Therefore more people bought the cheaper ones than the British luxury cars, that’s how America got the biggest auto companies after the British. The same things are happening here in emerging markets � in both India and China, and many other smaller new players � through pricing. For example, in the 1960s the Japanese produced the cheapest TV sets. As a result, most � I should say all � American TV manufacturers were wiped out, because they could not compete directly with the Japanese in manufacturing TVs, even though their technology and quality were slightly ahead of the Japanese at that time. They couldn’t compete.
The same thing is also happening but with different features. Back in the 60s, American TV manufacturers could not survive because they did not choose other options. Right now, the multinationals in the established markets can choose the cheapest place to manufacture their products, and also to provide services through those low cost locations. This is a tremendous change. Actually, it is the multinationals who drive the price down. For example, in China, a pair of shoes made by Nike or Adidas costs only about US$20 to manufacture in China. Let me repeat this, the shoes made by Nike or Adidas cost only a [fraction of] those made in the US or Europe. On average each pair costs only US$20 if they are manufactured in China. Then the retail price is $100 or more for their top brands. So, who makes all the profit in the process? If we examine closer at the issue we see that China as a factory to manufacture those shoes has only about $2 in profit. What about the rest? We’re talking about $80 in profits: they go to the brand holders, the wholesalers, the distributors and the sellers. So, those international parties actually make more profits in the process than the Chinese as manufacturers. So, this is tremendously different from the 1960s from the situation confronting Americans TV manufacturers. Number one, China and India are able to provide the cheapest and most effective labor force as well as complete manufacturing. Number two, the international parties control the technology, the plants, the distribution, and retailing through such ways and through such corporations. Though the price and basic has dropped significantly in manufacturing, but the profits go mostly to the international parties, be they technology providers or brand holders, or distributors or retailers.
Therefore these kind of price effects will be different from any other period in history. So China does give lots of advantages. International parties have come to allow Chinese or Indians to manufacture their products on their behalf, but most profits still go to the biggest multinationals. This is a new phenomenon. In this business chain we’re talking about everybody has become a winner: China or India are able to make some money by providing their basic services; but the biggest advantages go to the multinational companies. So, this is one aspect of pricing.
Another aspect is that the general price has to come down. For example, mobile phones. Several years ago, mobile phones were several times more expensive than they are now, but now the price has come down. One significant reason is that many mobile phone sets are manufactured in China. The labor cost is very low. We’re talking on average a Chinese manufacturing job pays only $115 per month. Number two, massive production scale is bringing down the manufacturing cost. Number 3, global distribution. Those 3 factors combined help to push down the price. Therefore, a lot of old mobile phone manufacturers have been wiped out. Now the power is concentrated among the top 5, even the French company Alcatel could not do it, nor could the European company Philips, so they had to drop out of the mobile phone business. Now on a global basis the top 5 multinationals become the [winners] through price reduction and manufacturing concentration.
Therefore it has everything to do with India and China, and other emerging nations. The third factor may be this. Although the Chinese and Indians are able to produce products at cheaper levels, they are not the only winner at all. This is because multinationals such as Dell or IBM or Nokia can do outsourcing to China, or India to help bring down the manufacturing costs. Therefore they are the biggest winners. For example, Sony can manufacture their microwave oven in China for about $30 per unit, which they can sell in the US market for $200 or more. So, Sony is the biggest winner in doing outsourcing to China. At the same time, China does play a big role in the process, because China is able to attract this business through a pricing gap, at the same time Chinese companies are able to sell their products on a global basis because their products are the cheapest, though they are not the best at all. Therefore this gives a surviving gap for the emerging companies in the developing nations such as India, Mexico and China or Vietnam. Therefore this pricing gap would have the biggest impact on international competitiveness on multinational survival and the next phase of global competition. Without this pricing advantage, the developing countries just cannot survive at all. At the same time, it also forces the multinationals from developed nations to readjust their strategies. So they must utilize the benefits offered by the developing nations for advantages, otherwise they couldn’t survive.
The auto market is another case. For example, Honda and Toyota are able to globalize their production and marketing globally but American giants GM is falling behind from internal problems such as high pensions, labor disputes and management chaos. So therefore GM must go through a [contraction]. At the same time, GM’s China business is booming. GM in China is already the second biggest player in China’s auto market, with a profit margin of maybe 5 or 6 times that in the US. Therefore, this GM-China venture is helping GM parent company back at home. The only problem is that China’s auto market now only stands at about 5.5 million units per year. That is small compared to the US. Therefore GM must do something at the competitive level in order to survive. And the price tag plays the most important route for GM’s long term health. So that’s the picture. [49.16]
JIM: George, let’s talk about something that’s very important to China in maintaining its manufacturing base, and growing its economy, and also something that impacts the rest of the world. I want to talk about China’s need for natural resources. We see that China is scouring the globe trying to secure sources of natural resources. Just the other day, CNOOC signed a $2.4 billion deal for Nigerian oil. How important is that and is there a possible conflict coming globally? In other words, with China’s voracious appetite for energy, the United States with 5% of the world’s population consumes 25% of its energy, if energy gets tight how does the world grow and do we avoid conflict regarding natural resources?
GEORGE: On one hand, China’s biggest economic growth comes from manufacturing. Manufacturing demands more and more resources and raw materials and components, therefore China has the biggest demand growth of oil, energy and raw materials. Therefore it has tremendous global impact, especially in this field. And unfortunately there is no way to avoid China going out into international markets to buy directly the supply or to take your words, the assets. This is needed. At the same time, there is another area of improvement that is badly needed. China’s manufacturing stands at very low level, that is, it is not energy efficient, it has a lot of old facilities which waste a lot of energy. For example, for every $100 product manufactured in Japan, it may cost little energy, but in China we’re talking about 5 times the Japanese. So that’s terribly bad, and needs a lot of effort to improve.
On a global basis China is having problems to find sufficient supplies, therefore we see Chinese companies increasing their efforts to buy natural resources assets or companies. To the established world, this may look like a risky business, that is they have to compete with China for global resources, but on the other hand you will see that this takes cooperation, because the natural resources the Chinese buy most is oil to ship back into Chinese manufacturing which manufacture international products for Sony, for Nokia, for Motorola, and GM. So it’s all interlinked. At the same time, China does have enough [of] most of the raw materials and oil and energy. So, we’re talking about China can take for example coal ,instead of oil for most power needs. At this time the US is the biggest global consumer of energy, oil, and raw materials. China is becoming number two. Even so, China last year only consumed about 7% of global oil supply. This rate may go up to 20% within the next 20 years, but I still see more cooperation and more sharing is needed, especially on the political side.
Americans consumers need to remember that China must get more oil, energy and resources in order to [do] the manufacturing. So this Chinese manufacturing requires more energy and more oil. At the same time, almost 50% of Chinese manufacturing has something to do with international demand. For example, in 2004, in terms of China’s exports, about 57% came directly from international operations within China. Another 15% of exports from China came from all sources demanded by foreign companies, which was done by Chinese manufacturers. So, all together, we’re talking about up to 75% of China’s exports comes from international parties directly, or indirectly, so everything is tied [together]. Therefore we need to get a new understanding about global economic realities, and interdependence - we need each other - especially in oil, natural resources and component supplies, which are these days are on a global basis. Unfortunately, this economic development is happening so fast upward that it has caught everyone by surprise, now it’s time to sit down and talk about cooperation, to talk about responsibilities and sharing with one another urgently. So, that’s what’s needed. [55:14]
JIM: George, what about the issue of Taiwan. And also as China’s economy has expanded, as the country has grown more wealthy, military expenditures are also increasing, and some people are uncomfortable with that. Address that issue, if you would.
GEORGE: Taiwan is crucial from the Chinese point of view because we’re talking about integrity. And on the political front, actually the situation across the Taiwan Straits is improving vastly. For example, 30 years ago, mainland China and Taiwan had continued military conflict, they were bombing each other on a daily basis, but now that has stopped. Over the last 20 years, huge economic ties have been developed across the Taiwan Straits. We’re talking about up to 2 million Taiwanese living in the mainland. About 70,000 Taiwanese companies are operating in the mainland. Also, we’re talking about more than $100 billion invested into the mainland by Taiwanese corporations. And this economic tie demands a better political relationship. One possible alternative I talk about in my latest newspaper articles is this: a better political structure through a federation. That is, Taiwan would become an independent political center within a Chinese federation. This would mean that Taiwan would maintain its political structure independent of Beijing. At the same time, the unity issue is resolved. This would bring lasting stability to the region. This region has been most troubled by, not only the last half century, but also for the last several hundred years - we’re talking about military conflicts in this region, especially by the Japanese. Now, it also involves the US and European interest. Therefore, it requires peaceful settlement one way or the other. For me, I would suggest a federal system as one way to resolve the issue. And Americans on the one hand pay enormous attention to the Taiwan issue, on the other hand, not very many Americans stay around to discuss possible resolutions to the issue. So we see more direct confrontation in terms of words, than very rational thinking on how to resolve this. I would say the situation on the Taiwanese is improving vastly as of today. We would hope as Chen’s term is over in Taiwan, the talk on unity issue would pick up steam, but of course this demands further political reform in China � I’m talking about Beijing � [it] needs to improve its political stance on numerous political issues. This would help to resolve the last obstacle on China’s unity issue with Taiwan. To me now, the picture is getting clearer, and also it stands a better chance at a peaceful resolution.
In terms of China’s growth in military buildup I would say this: if you look at China in the last half century also, you will see that in the 1950s the Chinese government had the biggest power hold in China. In this reform area, the Chinese government power has declined dramatically for several reasons. One is that China has increasingly become an open society. We’re talking about upwards of more than a - million multinational companies are operating in China today. Number two, the Chinese state sector only contributes one third of China’s economic output. The rest is being contributed from the private sector, as well as foreign multinationals. Therefore, the Chinese government on an economic basis is much less powerful than in the Mao era. In the Mao era it was 100% state sector contributions, 100% government monopoly of the market place, now we’re talking about only one third remaining. So that’s a huge change.
Also, in terms of progress of society and people you see huge changes in China. Right now, Chinese people can almost travel freely anywhere. The government no longer has any barriers. The Chinese people number one can travel anywhere globally. Number two they become much more expressive than in the era before. For example, we have more than 110 million internet users. They can talk almost freely on anything on the internet. This was undreamt of only 10 years ago, but it is happening. Number three, a lot of human interactions are going on. For example, we have several million international people living and working in China. Chinese employers alone have more than one million foreign nationals working for them. Then additionally there are several million foreign nationals working for foreign employers operating in China. This presence of huge [numbers] of foreign nationals in China is a great step forward for China, to become a truly new member in a global community. Therefore, I would say [there is] more positive development on the international relations from China. So, China is becoming more entrepreneurial, more open and more internationally involved than ever before. Therefore I would see less military strength coming from China within people’s power increasing and government power declining, more international involvement, therefore we should have less worries about any other confrontational issue today than at any time before. So that’s my thinking. [1:02:43]
JIM: A final question, how long do you think it is before international investors, American investors, can buy and trade stocks on an equal basis in China and won’t have to resort to different shares with different structures?
GEORGE: Policy changes in China do take a lot of time. But it’s speeding up like never before. I would expect to [see this] within a decade. This involves lots of issues, such as the exchange rate for the US. Also, institutional improvement in Chinese law, especially corporate law, better understanding especially for China’s government system. That will take time but I would expect that since China’s banking system is freeing up itself for foreign investment directly, therefore the capital markets would gather much quicker developments from now on. I would expect within the next 10 years or less China’s capital markets will be completely free for foreign investors - by then they should be able to trade just like any Chinese.
JIM: OK, well, George, I want to thank you for joining us from China, and that’s the wonder of the world we live in today, this interview is being conducted in late afternoon in California, that is, and I’m talking to you the following day early morning in China. It’s a wonderful world we live in.
GEORGE: Thank you very much.
JIM: The name of the book is called China's Global Reach: Markets, Multinationals, Globalization.
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