China changes its economic paradigm
By Gordon G Chang
Following two months of tussling with the Chinese government - much of it under
the glare of intense media coverage - Google Inc abandoned its core business in
the world's most populous nation. Specifically, on March 22, the Mountain View,
California-based company announced it had stopped censoring search results in
the world's most populous state. Users, the company posted on its official
blog, were being redirected to one of its Chinese-language sites in the Hong
Kong Special Autonomous Region.
Analysts wondered whether other foreign businesses would follow Google's
affront to Beijing's heavy-handed tactics and pull out of China. On March 24,
Go Daddy, the world's largest Internet domain name registration company,
announced that it would no longer register web addresses in China due to tough
new
personal-identification requirements. Network Solutions - Go Daddy's competitor
- had stopped accepting China's business in December 2009 for the same reason.
These incidents beg the question: has Beijing pushed foreign business too far?
Google provides a fascinating case study by itself: "World's biggest search
engine forced out of country with most Internet users". Yet there are broader
forces at play. While Beijing is developing a new model for economic
development, foreign businesses are reassessing the planet's most enticing
consumer market and rethinking China's potential.
The results of late Chinese-patriarch Deng Xiaoping's economic policies,
encapsulated in the official-mantra gaige kaifang (reform and opening
up), were extraordinary. Mao's successor began by first dismantling the Maoist
command economy and then opening China's markets to foreign competitors.
During the period known as the "reform era" - generally considered to have
begun in December 1978 and continuing through today - gross domestic product
increased at an average annual rate of 9.9% according to official statistics,
which may understate the extent of the expansion due to undercounting of the
most vibrant part of the economy, the private sector.
Yet the name given to this period can be misleading. The Party did not so much
reform China as ratify changes already implemented by hundreds of millions of
peasants, factory workers and entrepreneurs who, disillusioned by Mao's great
experiments, had abandoned Maoist notions and were determined to do things
their own way. Deng, when it came to domestic matters, deserves credit for the
good sense to step aside and let the Chinese people transform their own
society.
Similarly, Deng knew that China needed foreign capital, technology and
expertise, and paved the way for their entry by authorizing a tentative
opening. Once the first foreigners were in, however, he gradually - and wisely
- allowed barriers to fall as tens of thousands of managers and executives
pushed to relax rules constraining them.
The same dynamic of change existed during the tenure of Deng's successor, Jiang
Zemin, and Jiang's tough-minded premier, Zhu Rongji. Yet "reform" began to
stagnate and then went into reverse during the years of the Fourth Generation
leadership, led by Hu Jintao and Wen Jiabao. The pair has, since their
elevation in November 2002, pursued two broad initiatives that have turned back
the hand on Deng's reform and opening-up.
First, they have sought to renationalize the economy. In the second half of
this decade, Beijing began to use national-level instrumentalities - such as
the National Social Security Fund and China Investment Corporation (sovereign
wealth fund) - to buy shares of partially privatized state enterprises and
banks. The effect of this maneuver was to increase the percentage of state
ownership.
Renationalization gained momentum after the announcement of the State Council's
US$586 billion stimulus plan in November 2008. In 2009, the first full year of
the plan, Beijing poured, either directly or indirectly through state banks,
about $1.1 trillion into the economy according to the author's calculations.
Inevitably, Beijing's fiscal stimulus program resulted in a bigger state
economy and a smaller private one; about 95% of recent growth has been
attributable to investment, almost all of it from state sources (Xinhua News
Agency). Moreover, state investment went into the state sector, of course. The
state's stimulus plan favored large state enterprises over small and
medium-sized private firms, and state financial institutions diverted credit to
state-sponsored infrastructure. As they say, "the Party is now the economy".
Stimulus, which appears to be reduced this year, is continuing to build up the
already-dominant state sector (South China Morning Post).
This ongoing transformation not only undermines domestic private enterprises,
but also prejudices foreign businesses, shrinking opportunities. Yet
renationalization is by no means the major obstacle for non-Chinese
competitors. The second initiative of Hu and Wen is to use the rule book to
shut such businesses out of the domestic market. Since the middle of 2006,
Beijing, by issuing a flurry of decrees and orders, has adopted a decidedly
hostile posture toward foreign multinationals.
Of special relevance are regulations, released in August of that year,
permitting the Ministry of Commerce to block foreign takeovers [1]. Beijing,
worried about the "loss of economic sovereignty", which in its view included
the loss of control of large enterprises, was not hesitant to challenge
takeovers by multinationals. At the end of 2007, for instance, Microsoft was
not permitted to buy a stake in Sichuan Changhong Electric, a television
manufacturer, ostensibly because of concerns in Beijing that the sales price
was too low.
Two Goldman Sachs deals in 2007 were also blocked by central authorities. The
investment concern was thought to have negotiated too good a deal to buy stakes
in Midea Electric Appliances and Fuyao Group.
Carlyle, the American investment group, originally agreed to buy 85% of
state-owned Xugong Construction Machinery. The proposed stake was then reduced
to 50% and then 45%. The deal, originally signed in 2005, was eventually killed
by the Ministry of Commerce through, among other tactics, inaction and delay
(China Daily). Carlyle gave up in 2008.
Most worrisome, Beijing used its Anti-Monopoly Law, effective August 2008, for
the first time when it rejected Coca-Cola's proposed acquisition of China's
leading fruit juice company. The Ministry of Commerce, in March 2009, said the
proposed $2.4 billion merger with Huiyuan Juice Group might end up increasing
prices and squeezing out smaller producers. The government's action, hailed as
a "landmark", proved a questionable decision.
Hong Kong-listed Huiyuan controlled only a little more than a tenth of China's
$2 billion juice market and Coke had a 9.7% share. In any event, the Ministry
of Commerce provided almost nothing in the way of explanation or rationale.
Yet, the irony is that Beijing saved Coke from overpaying for Huiyuan. The fact
that Chinese officials stopped a takeover of a run-of-the-mill enterprise in a
non-sensitive industry by a foreign business despite its willingness to pay a
vastly inflated price is also a sign that there has been a fundamental shift of
attitude.
The Chinese government, of course, denies there has been any such change in its
policy. Yet it is undeniable that, for the past three decades, Beijing had
committed itself to attracting foreign capital, and now it appears to be
backtracking. The perception underlining this new attitude is that foreigners
have captured "excessive" market shares and own too much technology. There is
also a fear of an overreliance on foreign direct investment.
Moreover, Chinese ambitions are much bigger these days. Beijing is attempting
to build "national champions" and wants 50 of the world's 500 largest companies
to be Chinese within the next decade. The Chinese, in short, want to keep their
expanding market for themselves.
That, among other factors, is motivating Hu Jintao's "indigenous innovation
product accreditation" program, which, to obtain accreditation to sell to
governments in China, requires the ownership of foreign technology and
trademarks by local enterprises. This attempt to obtain intellectual property
has naturally sparked controversy and almost universal opposition from foreign
businesses and governments. In this climate, it is no wonder the latest survey
from the American Chamber of Commerce in China shows a growing percentage of
businesses - now 38% - which feel unwelcome in the country.
Google certainly felt unwelcome. It was undoubtedly perceived as too big, too
foreign and too successful, and therefore the central authorities felt
compelled to undermine its operations. In a January 12 entry on the company's
official blog, it announced it was no longer willing to filter Chinese
searches. Yet the dispute, however framed, was more than just a struggle over
government censorship. In the statement, the search engine stated that in
mid-December it had detected "a highly sophisticated and targeted attack on our
[Google] corporate infrastructure originating from China that resulted in the
theft of intellectual property from Google". According to the statement, at
least 20 other large companies had been hacked. In Google's case, the attacks
targeted the Gmail accounts of human rights activists in China, the United
States and Europe and the company's source code.
With Google's source code, cyberintruders could penetrate the search engine
with ease. Due to "the Great Firewall", another name for Beijing's tight
Internet controls, no independent group of hackers could have carried out
coordinated attacks without either official support or implied consent.
Moreover, no organization in China outside the central government, the
Communist Party and the military has the resources to maintain large-scale and
concerted efforts.
Therefore, the inescapable conclusion is that, if the attacks on Google's
network originated in China, the Chinese one-party state had to be behind them.
"The fact is that everyone in the US government who looks at these cyberattacks
admits privately that they have the evidence: the attacks are from the Chinese
government, and not rouge hei-ke," says John Tkacik, retired State
Department intelligence specialist on China and author of Trojan Dragons,
a 2008 survey of Chinese cyber spying published by the Heritage Foundation [2].
In fact, VeriSign's iDefense Labs, an American Internet security firm, traced
the attacks on Google back to the Chinese government "or its proxies".
The US government has begun to discuss China's cyberwarfare campaign in public
only because Google forced its hand. Beijing was responsible for a "DNS
poisoning" attack that caused Google to crash worldwide last June, and the
company was perpetually harassed by Chinese hackers since its arrival in the
country in 2006. That is one of the reasons why Google's business never took
off in China. Its market share in that country was only 36% before its
withdrawal, far behind local competitor Baidu's 58% at that time. Google may
have made missteps entering the Chinese market, but Baidu got to where it is
largely because of crucial help from central government authorities.
Google thinks it can salvage its business there. Beijing, predictably, began to
block searches that had been routed to Hong Kong. More ominously, Chinese
officials are already pressuring the big state-owned cell phone companies -
China Mobile and Unicom, the two largest operators - to break off relations
with Google, which wants to launch its Android phone. And the American company
has been the object of Cultural Revolution-style attacks in state media that
can't help but talk about America's "information imperialism", Google's
"deliberate plot", and the link between the company and the Opium Wars. "Google
is not God and Google is not a 'value virgin'," wrote People's Daily, the
Communist Party's flagship publication, just after the US company announced it
was shutting down its China search engine.
So far, we are seeing a spiteful response from an angry government. And a
government that will go to great lengths to make sure the Chinese market is
reserved for Chinese competitors. Google's recent troubles show us that Beijing
has a new economic paradigm, and it is not a good one.
Notes:
1. See Regulations on Acquisition of Domestic Enterprises by Foreign Investors,
promulgated on August 8, 2006 and effective September 8, 2006 (issued by the
Ministry of Commerce and five other agencies).
2. John Tkacik, e-mail message to author, March 27, 2010.
Gordon G Chang is a Forbes.com columnist and author of The Coming
Collapse of China.
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