Daily Archives: June 3, 2010

Toward an Understanding of the China Problem

In this post, I will attempt to pull together some interrelated and overlapping observations (which I have touched on previously) and synthesize them into what I hope will be a rough framework for understanding some of what’s been happening to the global technology industry.

This is a blog, however, and not a book, so I’ll be painting in broad brushstrokes. Some generalizations will be closer to the mark than others, and for that I readily apologize. Still, I thought it was time to write this particular piece. Let’s get on with it.

The very thing that the helmsmen of market-based capitalism wanted most of all might have sewn the seeds of its decline.

Transnational corporations obviously wanted globalization. It would give them access to new sources of growth in foreign markets; it also would provide access to new investment opportunities, new supply-chain relationships, and new pools of low-cost labor. If you were a corporate chieftain, what was not to like about globalization?

But perhaps they forgot about the enduring, immutable law of unintended consequences.

In some ways, globalization has undermined market-based capitalism’s formula for success. For years, as global markets were regulated and protected, corporations struck a tacit pact, or a socioeconomic contract, with the governments and peoples in their home markets and their primary sales territories.  Corporations would generate returns for their shareholders, governments would benefit from corporate tax revenue, and the people would benefit from jobs at the corporations as well as from the infrastructure and services that taxation funded.

But, with globalization – especially in the context of the aftermath of the global financial crisis and China’s rise as an industrial hegemonic power – the old models and verities are unraveling. Many transnational corporations, who serve shareholders before all others, might be compelled by circumstance to reassess their accommodations of enlightened self-interest with governments, employees, and other secondary stakeholders in their home markets.

What I am suggesting here, in a roundabout way, is that globalization set the stage for China – with its massive domestic market and its command-and-control state-based capitalism — to steal a march on market-based capitalism’s standard bearers.  While the social compact in developed markets seemingly has broken down, China has fashioned an impressive alignment of interests between its political rulers, its people, and its geopolitical industrial strategy.

Keenly attuned to history, China’s rulers recognize that it’s easier to run an immense country with the implicit consent of the population than without it. China’s political masters have been careful to ensure that China’s people benefit from the country’s economic growth and industrialization. That’s why we see policies like “indigenous innovation,” designed to ensure that homegrown Chinese companies, products, and technologies are favored domestically over their foreign counterparts. The Chinese market is a big market, and if Chinese companies can dominate there, they will have the economies of scale to compete successfully, in many market segments, on the global stage.

China’s authorities recognize, at a fundamental level, that their long-term political control is inextricably linked to how well they pacify and placate the Chinese population. Providing people with jobs, rising income, and improving standards of living will be essential to the long-term rule of China’s political elite. This is why China will not allow itself to remain in the relative ghetto of commodity-product manufacturing. The Chinese authorities have devised an intricate, sophisticated plan that envisions the country and its people ascending the technological value chain, moving up from low-cost manufacturing to higher-end innovation and research and development (R&D). That transition won’t be easy to achieve, but it has begun.

Look at what is happening in many renewable-energy markets, such as photovoltaics and wind power, where Chinese companies are trying to advance from the manufacture of cheap knockoff products to the development of innovative breakthroughs. They have a lot of work to do, especially on wind turbines, but the plan clearly is in place.

In computer networking, Huawei went from, um, emulating the likes of Cisco Systems and Alcatel to developing its own standards-based networking products that now compete nearly as much on quality as on price against products from longtime market leaders. Cisco CEO John Chambers has said Huawei increasingly is his biggest global competitor, and he is not flattering to deceive.  It’s no coincidence that HP bought 3Com, which had transformed itself into a Chinese company with an American façade.

Meanwhile, the information-technology industry is commoditizing, a process intensified by what HP terms “labor-market arbitrage” – a euphemistic phrase denoting a transfer of jobs across international boundaries to where they can be done cheapest – and increased automation of functions that formerly were delivered by humans. At the same time, the global economy is undergoing a major realignment, as tapped-out consumers (and many governments and businesses, as well) in Western markets can no longer fulfill their role as consumption catalysts. Growth is occurring elsewhere – in the BRIC nations and beyond – and jobs are moving with it.

When the developed-world’s consumers could still buy more stuff than they actually needed, China – the world’s manufacturer – was more than content to buy U.S. treasuries to sustain a mutual relationship of convenience. Now , though, as the U.S. consumer engine sputters, China is reassessing its options. Already, we’ve heard Chinese officials say the U.S. and Europe are “less indispensable” to China’s strategic aspirations than they were in the past. Chinese has begun cultivating its own consumer economy, but it’s doing so under a state-controlled capitalism that espouses “indigenous innovation,” under which Chinese companies will keep most spoils and benefits at home.

Many Western technology companies are banking on growth derived from sales of products and services in China. As long as China pursues policies of nationalist mercantilism and indigenous innovation, those growth expectations are unlikely to be realized.

The only way Western companies will be allowed to derive big contracts from China’s biggest customers, most of which are owned or affiliated with the Chinese government, will be by moving their core R&D efforts and initiatives to China, which will make them subject to that country’s intellectual-property rights (IPR) and laws. This strategy amounts to a very different type of labor arbitrage from the one to which transnational companies have subscribed.

Fear not, though, because Chinese regulations and laws pertaining to intellectual property will become more effective and protective as China gains the upper hand in innovation and R&D. As HP has figured out, China doesn’t so much care that a company is Chinese as long as it plays by China’s rules, which will entail doing an increasing percentage of innovation and R&D in China, and not elsewhere.

Think about that.  It might be a beneficial arrangement for corporate shareholders – though that remains to be seen – but it’s not so good for engineers, researchers, and many other knowledge workers in Western economies.

I think this dynamic, the zero-sum rise of China at the direct expense of many of us in the developed world, is a problem that needs to be recognized and addressed. What China is pursuing is not your father’s market-based capitalism, in which the benefits of trade presumably would be widely shared worldwide. This is a different model, one guided primarily by geopolitical considerations. As it gains ground, it will have major repercussions worldwide.