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Present at the Creation
This book is about the impact China will have on the global balance of wealth and power in the twenty-first century. We are particularly concerned with how the United States and China will interact not just in the next few years, but over the next several decades, and with the implications of those interactions for the economy, business, and the global order.
In our assessment, China remains positioned, if things go moderately well, to become the world's largest national economy sometime in the 2030s. Despite the setbacks associated with the current Asian financial crisis, the turmoil in world markets, and the slowing growth of economic output and foreign investment in China, we believe China will reemerge as a vibrant economy early in the next century and increasingly show itself as a super-power in every sense economically, politically, militarily, culturally, technologically.
China, however, will be different than any great power the world has ever seen. The political-economic system it will evolve a unique hybrid of many influences, including elements of socialism as well as capitalism will also be different than any system the world now knows.
The stakes for American business are of towering proportions. For a growth-hungry industrial world, the China market could represent what the New World meant for Europe several centuries ago: a huge new land of dynamic growth, possibility, and profit. It may also be the fulcrum of global competition, where companies compete for market share and control of the engines that drive cost curves down and consumer benefits up. To become the integrated,networked, and truly global corporation of the future, participation and even a measure of leadership in the China market may be a virtual requirement for all companies.
For nearly two decades it has been apparent that trade flows and capital flows, and the wealth and power that derives from them, are shifting from the old Atlantic-centric world to an increasingly Pacific-centric world. What has become evident more recently is that China lies at the heart of this Asian shift. The United States and the American business community are, of course, powerful and sometimes even dominant forces in the new Pacific-influenced order. China is in the process of dramatic changes, and Americans stand to benefit enormously from those changes if we understand and adapt to them properly.
Inevitably, different corporations will have different assessments of the opportunities and the risks, especially now that East Asia is trying to cope with a continuing and troubling economic shakeout that is the legacy of more than a decade of hypergrowth, overbuilding, overinvesting (often in the wrong sectors), as well as overleveraging.
China has obviously not been immune to the Asian flu. The thunderclaps of bad loans, collapsing currencies, failed banks, and plummeting equity prices that rolled through Thailand, Malaysia, Hong Kong, and South Korea, and that have been throttling the once mighty Japanese economy for years now, are bringing massive pressure to bear on China's emerging economic structure. Even now, the full impact cannot be calculated, either on China, which has, at this writing, not yet been thrown fully into the maelstrom of Asia's crisis, or on the other Asian countries, where enormous problems still fester. It is clear, however, that many American business and financial strategists are now spending more time thinking about protecting themselves from the downside dangers of Asian recessions, banking crises, and contagious effects on profits and equity values than they are about exploring new investment and opportunities in the region. And there are still plenty of reasons to worry: among them, the process of competitive devaluations of Asian currencies, which could lead to choose your poison global deflation and crisis, or "only" a record-shattering American trade deficit.
As the "Asia crisis" has spread to Russia, Latin America, and even Wall Street and Main Street, USA, China has worked indefatigably to stay on course with the growth and modernization of its economy. With Japan scarcely able to form a government (let alone pass meaningful legislation to address its banking crisis), with Suharto deposed in Indonesia and Mahatir on the ropes in Malaysia, with Bill Clinton mired in scandal, Boris Yeltsin unable to govern, and Helmut Kohl rejected by German voters, even the punditocracy of The New York Times concluded that China's leadership team, headed by President Jiang Zemin and Prime Minister Zhu Rongji, might be the world's most stable and consistent government.
And in Washington, where economists and Clinton administration officials huddled regularly in 1998 to worry about the crisis that was mushrooming into the worst threat to the world economy in half a century, China was almost universally seen as a critical player, if not the critical player. On the one hand, by continuing to grow its economy, even if more slowly than before, and by steadfastly refusing to join the Asian currency devaluation game, China was said to be keeping the Asian house of cards from falling down completely. On the other hand, the fear was rampant that if China were to fail, devalue its currency, and succumb to the Asia crisis, the worst-case scenarios would be unleashed upon the rest of the world economy, including the United States.
Thus, despite all the intense pretrip criticism of Clinton's July 1998 visit to China (criticism that centered on human rights, China's lack of internal democracy, its policies toward Tibet and Taiwan, and other moral and ideological considerations), most American/leadership figures came to support the administration's efforts to warm up and improve Sino-U.S. ties. China's willingness to do the right thing in the face of the Asia crisis contrasted sharply with Japan's unwillingness and/or inability to do the right thing, making China appear to many as America's more logical partner in Asia, even though its total economy is still far smaller than Japan's.
China is not out of the woods yet. It is not clear that Beijing's leaders can live up to their oft-stated commitment not to devalue their currency, no matter how much "face" they have invested in taking the high road on this question and no matter how much pain they have already accepted (especially in Hong Kong, which is in a deep recession), in order to keep the Chinese renminbi and the Hong Kong dollar stable. Nor is it clear that Zhu Rongji's sound and well-intentioned course of domestic-led investment and State-Owned Enterprise reform can be implemented fast enough or thoroughly enough to continue to insulate China from the threats of Asian depression, an international credit crunch, asset price deflation, and other destabilizing external trends, let alone the magnifying internal economic challenges.
The Chinese trade surplus with the United States is rising to politically toxic levels, even if there is little real economic damage. And a new stream of protectionist edicts are coming out of Beijing that anger American businesses even as they defy Western logic: Why would they be making it more difficult for foreign companies to do business in China at precisely the moment they most need new foreign investment? Yet these measures have their own internal political peacekeeping in China. We can therefore expect this trend toward more difficult cross-border trade and investment to continue, becoming a potential new irritant in a U.S.-China relationship that is otherwise improving on an overall basis.
So there is much to worry about on the subject of China's short- and medium-term future. One way or another, however, we believe this extraordinary period of global crisis will pass. China, Asia, the United States, and the world economy will readjust over the next several years to new prices, new values, new realities, and a new global economic paradigm. The trade and capital shift toward Asia is likely to reestablish itself and even accelerate ia the next decade. As it does so, the stage will be set for a new China rush.
Some of the more visionary global corporations see the current environment as a positive long-term opportunity for buying assets and investing at deflated prices in the region. Others see it as a reason to mute their enthusiasm, curtail their operations, and wait to see if and when Asian economies regain their growth trajectory. On this and other basic questions about China, some will get it right. More than a few will fail. Over the next quarter century, success or failure in China may be the margin of difference for some in the global competition. It may even be a leading indicator of the soundness of overall corporate growth strategies.
The stakes are equally high for government policy makers and the American public at large. The sheer size of tomorrow's Chinese superpower is enough to warrant reconsidering the future of just about every major global issue. But the challenge of understanding and dealing effectively with China is not about size and scale alone. The different interests that flow from China's history and different political-economic assumptions compound the challenge enormously. They require much more thoughtful analysis than they usually receive, either in the facile media discussions about investing in or doing business with China or in what passes for the process of political strategy formulation in Washington.
If we fast-forward several decades, we will find a world in which China and the United States are the two superpowers. Their power will have different sources, and they will have different ways of making their influence felt, different goals, and different strengths and weaknesses. In our judgment, the United States will still be the much more capable, in-depth, and efficient power, with far more advanced technology and more sophisticated mechanisms of projecting its influence globally, both in economic and military terms. Nevertheless, the aggregate size and the scope of China's economy, coupled with its centrality to Asia and its precedent-setting influence throughout the developing world, will make it a formidable and unique superpower in its own right. There will obviously be much to gain for both the United States and China through constructive partnership. But even more important, the dangers to both sides and to the world will be very great if the politics of confrontation dominate the relationship.
Unfortunately, what appeared in the early 1990s to be the beginning of a beautiful relationship soured in the frosty winds of a new cold war during the first four years of the Clinton administration. Despite the positive outcome of the administration's reassessment of its China policy in 1997, and President Clinton's successful trip in the summer of 1998, the improvement in relations is still too thin and weak to be certain of how long-lived such a trend will be. Dogged by his domestic scandal even as he traveled through China, Clinton has not been able to devote much attention to the kind of proactive and constructive relationship building needed to bridge the U.S.-China gap. It remains fashionable in some quarters in Washington, especially now that we have entered more economically uncertain times, to posit a "China Threat," a threat that Americans must prepare to confront and contain. Our view, however, is far more hopeful. China will challenge our society in profound ways and pose vexing problems. But on balance, we expect that the United States and China, as the two great nation-state superpowers of the twenty-first century, will find the way to compete, cooperate, and coexist peacefully.
The China we write about is one we have followed closely and experienced firsthand since we were in our twenties. Although we did not know each other at the time, we both made our first China journeys back in the early 1970s, when China was still caught up in the whirlwind of its Cultural Revolution. The dogmas and ideological passions of Maoism defined every outward aspect of what the visitor saw and experienced.
We were both separately and to different degrees captured by the romance of the Maoist rhetoric and the dream espoused by the Cultural Revolutionaries of creating a new utopian society in China. For both of us, coming to understand how the reality of China in the late 1960s and 1970s differed from Beijing's official party line about it (and just how severely dystopian the Maoist vision proved to be in practice for the Chinese people) ultimately involved powerful and emotionally wrenching life lessons. But among other salutary benefits, it taught us to look beneath the surface of Chinese society to understand the deep and complex forces that shape it. This is an important skill and a critical point of departure in looking at China today, even though its society has become more modern and open.
Traveling in China during that time period afforded us a chance to be present at the creation of modern Chinese "business" and the modern Chinese market economy. Despite the chaos and extremism of the Cultural Revolution, it was during the early 1970s that Deng Xiaoping's arguments about economy building were first beginning to be heard behind the walls of Zhongnanhai, the Beijing compound where the supreme leaders of the Chinese Communist Party dwell. After enormous political battles and the death of Mao, the resilient and tenacious Deng gained the Upper hand politically. He began to bring the country's nightmare of fierce internecine struggle to an end. For the first time since the 1950s, China's political leadership began to define their tasks and the nation's future according to the needs of broad-based economic growth instead of political campaigns and ideological dogmas.
Thus, by the time of our travels in the late 1970s we were eating noodles at the first few private restaurants to open in China. We went down to the farms and met the various "rabbit ladies" and "chicken kings" who had made legally sanctioned private fortunes by raising their own animals and crops and selling them directly into the rudimentary market, instead of through the state system. We talked to managers of the first few enterprises that had discovered (usually with eurekalike brainstorms) the powers of advertising, marketing, and even mergers and acquisitions.
We witnessed the shift in the U.S.-China trade from "trading with the enemy" to the birth of what today is already a $100 billion a year relationship, on its way to becoming one of the central economic relationships in the world. We were asked by Chinese corporations for advice on everything from attracting foreign tourists to buying foreign steel fabrication plants. We advised major American and other foreign corporations as they tried to enter the market for the first time with products and services from rental cars to Western cosmetics. More recently we have been involved in significant corporate investments, venture capital start-ups, and LBOs of Chinese companies.
We vividly remember what it was like in the early 1970s to cross the little bridge at Lo Wu between Hong Kong's New Territories and the village on the Chinese side then known by its Cantonese name, Shimchun. It was as tense a border as any in the world, akin to crossing from West to East Berlin at Checkpoint Charlie during the height of the Cold War. On one side, American and British intelligence agencies kept their high-powered lens focused on who was coming and going. On the other side, ever vigilant "Red" Chinese border guards kept their weapons at the ready. In those days, almost everyone carried their own baggage across the bridge into China. Mao had made a point in his writings about the proletarian virtue of carrying one's own bags, so porters were in extremely short supply. And if you could find one, you wouldn't tip him. In the spirit of the prevalent slogan of the day, "Serve the People," tipping was disdained throughout China.
Walking across the bridge, you could almost hear the vacuum seal closing off the global economy behind. Ahead were big red signs with the sayings of Chairman Mao and the peasants of Shimchun tilling the green tropical rice fields as they had for centuries. Today, Shimchun is better known by its Mandarin name, Shenzhen. Business travelers coming from Hong Kong now arrive via superhighway in a speeding Mercedes or Lexus if they don't helicopter or fly in. Shenzhen has become a city of over a million people and the home to hundreds of foreign businesses. Most of the paddy fields have long since been devoured by the skyscrapers, department stores, and urban sprawl of this experimental "special economic zone."
The big red sayings of Chairman Mao are gone, replaced by equally prominent advertisements for Marlboro and other Western consumer goods. At the Shenzhen Shangri-La Hotel, there are plenty of porters eager to carry your bags, most of them too young to have read Mao's writings on the subject and all of them eager for tips. A single political billboard is visible on the hills above downtown Shenzhen. A visionary-looking Deng Xiaoping promises that China will not change its basic policy of economic reform and opening for one hundred years.
No one can possibly imagine what China will be like in one hundred years' time and have any hope of accuracy. The furthest we have gone in these pages is about three decades, which roughly balances the three past decades during which time we have been actively following developments in China. Knowing from firsthand experience how much China has changed in the last thirty Years provides us with a certain personal framework for judging how much change is or is not possible in the next thirty.
From the vantage point of the middle of our lives, we have tried to think about what China will look like as we approach the later stages of our own lives. We have imagined what the interactions may be between China, the United States, and the rest of the world when our children, who today are not yet teenagers, arrive at the middle of their lives. We have sought, in short, to do what the Chinese have done for centuries: think long term about decades instead of quarters; about the next era instead of the next year.
Significant new events affecting China, Asia, and U.S.-China relations have taken place since the hardcover edition of Big Dragon first appeared in March 1998. So far, nothing we have seen fundamentally changes the framework of analysis set forth within this book. Most new developments were forecast or alluded to in one way or another in the earlier volume. Nevertheless, our readers may wish to know our thoughts more specifically on at least some of these crucial developments:
The Crisis in the World Financial System
We touched on this issue briefly at the outset of this introduction. As this is a protean, constantly changing phenomenon defined by its volatility, it would be foolish to attempt too specific a forecast. However, it is worth making a few key observations:
* China has Asia crisis-like symptoms within its system, such as lack of transparency, too much government interference, insufficient market mechanisms, and crony capitalism writ large. Nevertheless, the problems of China's financial system do not necessarily arise from the same sources as the problems in other Asian countries, nor do they necessarily have the same solutions. China still has sufficient political control of certain issues to solve them politically. Currency value is a prime example: Since the RMB is not freely convertible and foreigners cannot play the Chinese currency market except in the most obscure ways, the currency cannot be devalued from external pressure as it was in Indonesia of Malaysia. Beijing might decide to devalue its currency in the future, but not for the reasons foreign experts usually suggest (i.e., to stay competitive on manufacturing cost with other Asian countries that have so greatly devalued their currencies). In our view, the incredibly low cost of Chinese labor (and the comparative efficiency of foreign manufacturing in China as compared to other Asian countries) keeps Chinese exports generally competitive witness the rapidly rising trade surplus with the United States. China is therefore not compelled to devalue as some experts have suggested. If China devalues at all, our expectation is that it will be primarily to make foreign inward investment, which is currently falling precipitously, cheaper and therefore more attractive, so that foreign capital can again play the kind of invigorating role it did in the early '90s boom.
* Some interesting theories have also been spun to suggest that China deliberately held back on devaluation in 1997-98 in order to please Washington and therefore convince Americans that China was a more reliable partner and leader for Asia than Japan. To this interesting theory, we politely say, "bunk." While we note the highly responsible role that China has played in this difficult situation, and the degree to which that is appreciated in Washington, Chinese policy will continue to be driven by what is best for Chinese interests. Those Chinese thinkers who may be focused on the question of "who should lead Asia" tend to think about this in terms of decades and centuries. They are in no hurry to assume the costly burdens of leadership when they are still over their heads in the task of pulling China out of feudalism and into the modern age.
* Russia's economic implosion in the summer of 1998 has dealt a deathblow to anyone still dreaming about encouraging China to take the route of shock therapy, radical privatization, or quick electoral democratization. When Russia became a magnet for foreign investment in 1997 and the Russian stock market was briefly churning out billionaires and spectacular returns, there was a momentary renewal of the decade-old argument that China too should take this road. Russia's flameout has only served to validate the Chinese Communist Party leaders who have always argued that economic reform in China should be a slow, gradual, incremental process, with political reform on the back burner.
* America's own recent problems with speculative excess in our financial markets have diminished the credibility of Washington's argument that the solution to the Asia crisis lies in rushing more rapidly toward free and open financial markets. From precipitous stock market plunges to hedge fund blowups, what the Chinese have seen recently of U.S. financial markets is being used to reinforce the argument that the foreigners have no miracle potion and that China must find its own way.
* Even if China remains largely insulated from the full effects of the crisis felt by other Asian countries, there is no doubt that China is experiencing a major setback to its growth and modernization plans. The drying up of investor interest from other Asian countries, the collapse of demand for Chinese exports in other Asian countries, the severe recession in Hong Kong, and diminution of world financial markets' willingness to absorb public offerings of Chinese companies all of these factors are bringing down the former double-digit trajectory of growth in China. Although we believe China will eventually resume a high growth track, those who invest and do business there will need to be even more patient than they have already been as the whole region digests what has happened to it and begins to rebuild.
President Clinton's Visit to China
In June 1998 Clinton's visit fulfilled Big Dragon's number one policy recommendation (chapter 18) and demonstrated what a policy of "dynamic engagement" could accomplish. The "debate" about human rights Clinton held with Jiang Zemin on a live television broadcast, as well as the speech Clinton gave to students at Peking University (followed by a question-and-answer session with students), showed what a truly "normal" relationship and a policy of engagement could achieve. That is, the United States and China could cooperate closely, launch many constructive joint initiatives, and yet continue to disagree on some fundamental issues.
Clinton was right to go to Beijing. American ideas about democracy and human rights were heard because he was there, not because they were trumpeted by neo-isolationists in far-away Washington. Clinton's trip to Beijing achieved a truce in the cold war that had been brewing previously, a cold war we described in detail in this book. At least for a time, the "coming-conflict-with-China" school went into recess. The general discussion of China in the media, when not eclipsed altogether by economic concerns and domestic American political distractions, became less strident and inflammatory. (Of course, it has also helped that Clinton's political opponents, who had previously thought that China policy was an issue on which the president was vulnerable, now have better issues to indulge for their partisan purposes.)
Yet while the Washington-Beijing cold war has started to fade, the danger is that China policy remains a mile wide and an inch deep. While constructive dialogue is taking place and the overall atmosphere remains cordial and respectful, large, unresolved issues lurk just below the surface. A projected $60 billion annual trade deficit with China will certainly prove politically challenging in the 2000 election, particularly if there is a further downturn in the U.S. economy. U.S. exporters, meanwhile, are complaining that Beijing is beginning to close its doors by instituting import and investment curbs in key fields such as power generation, pharmaceuticals, machinery, and telecommunications. This may lead many of the affected companies some of the largest and most politically influential in America to rethink their hitherto strong enthusiasm for better U.S.-China ties. If another major "anti-human rights" or "anti-democracy" event occurs in China, or a new conflict arises over Taiwan, the cold war atmosphere could quickly and disastrously return.
Nearly two years have elapsed since the transition of Hong Kong back to Chinese rule. Few of the major fears expressed by the pre-handover doom-sayers about curtailment of rights and freedoms have come to pass. Hong Kong's life as a Special Administrative Region of China since July 1, 1997, has been marked with great success on the points that foreigners and critics were most concerned about. Ironically, while China has generally maintained the political status quo, Hong Kong has been hit with enormous unexpected challenges to its economic life posed not by greedy or power-hungry Chinese commissars, but by the impact of the capitalist-induced Asia crisis. Yet even faced with unprecedented economic challenges, China has been remarkably restrained and noninterventionist, at least to date. We feel that the positive general outlook expressed on Hong Kong when we wrote that section (see chapter 15) has been validated, although we are, of course, concerned about even the small political problems that have come to the fore.
It would be naive to think the challenge in Hong Kong is over or settled. Hong Kong must wrestle with a fascinating conundrum: It is universally acknowledged to be among the freest markets in the world, yet the value of its currency, under the U.S. dollar peg system, is set by political fiat. We suspect the Hong Kong dollar needs to be devalued significantly for the sake of the short-term interests of revitalizing the local economy. But many fear that any change in the U.S. dollar peg would be a sign that the status quo in Hong Kong has been abandoned. Squaring the circle allowing the Hong Kong dollar to fall to a more rational market value and yet keeping stability and the status quo intact will be a huge challenge in the period ahead.
The Acceleration of Internal Economic Reform
The selection of Zhu Rongji as prime minister in 1998 was a very positive portent. Senior American officials who have met with him, and most bankers and business leaders as well, come away with the impression that here is a Chinese political leader who has the courage, the vision, and the technical knowledge and skill to tackle China's economic challenges and move the country forward into the twenty-first century. His selection as prime minister tells us that the Chinese leadership knows it must forgo the "easy road" of ignoring the enormous fundamental problems of the economy. If anyone can prevent Asia crisis-type problems from boiling over in China, it would seem to be Zhu Rongji. However, as we often note in our discussions with American leaders and policymakers, it is important to remember that he is but one individual an extremely important and capable person, to be sure but one who must work in the framework of a collective leadership, the existing political and economic consensus, and the many limitations posed by China's stage of development. Even he, with his receptivity to new ideas and bold pronouncements about 8 percent annual growth and the overhaul of the State-Owned Enterprise system, cannot make these things happen without the kind of favorable circumstances that are suddenly in short supply.
At a more general level, we note that there has been a kind of a new "Beijing spring" developing recently in China. The range of ideas publicly discussed, the new spectrum of books and magazines being published, and the flourishing of the Internet and other new media are all positive, hopeful signs that an increasingly wide and sophisticated debate is taking place within China over many issues, including the most important matters about China's political and economic future. (We like to think that the publication of a Chinese edition of Big Dragon, which came about after a minor "bidding war" among leading publishers and was translated and published in record time to coincide with President Clinton's 1998 visit, is one small indicator of the expansion of ideas that can be officially published and discussed.) While there are many things that, unfortunately, still cannot be said in China and many viewpoints that cannot be freely heard, we are deeply impressed with how much opening has occurred in the last year or so.
A key mission of Big Dragon is to present China in its many dimensions, to avoid the quick sound bite and explore instead China's always complex, often ambiguous and contradictory realities. We have divided this book into five parts. Each provides a different, yet related, lens for looking at the China of today as well as tomorrow.
In Part I (Inside the New Cold War), we look at China through the window of the most troubling of all the issues on the table: the dangers of drifting into a destructive and unnecessary cold war between America and China. The Washington-Beijing relationship has undergone several shifts in the last decade. In the early 1990s, a bright, optimistic time prevailed. Then from 1993 to 1997, the environment was characterized by high profile ideological-political battles, virulent trade and economic disputes, the demonizing of China as a new "evil empire," China's provocative behavior on several fronts, and even military sparks over Taiwan. How and why the United States and China descended so quickly into this new cold war, what the stakes are for Americans, what could happen next, and how to avoid the worst-case scenarios are all subjects discussed in this first section.
In Part II (Benchmarking China), we illustrate some of the ways i