TCS Daily


China's Interesting Journey

By Rowan Callick - August 8, 2006 12:00 AM

If China really wants to be viewed as the second great global power, it should make its currency convertible, and let its value be determined by the market. It should rein in its exporters from gaining an unfair edge. It should allow a freer flow of information, and give courts the independence to determine their own judgments, especially in contract cases.

There's a loose consensus in the West that, if the above are not exactly China's present goals, they should be -- and that they almost certainly will be sooner or later.

Wrong. China is not heading in this direction. It's going its own sweet way, and those who have business with the country need to come to terms with this fact.

As usual, it is left to the Americans to raise the alarm. Other countries' politicians or senior officials who come to China, somehow find it hard -- let's be frank, impossible -- to say what they too must know.

The US Under-Secretary for Commerce, Frank Lavin, told the Australian Chamber of Commerce in Beijing on July 31 that there was "a worrisome trend where not only the sense of reform is fading a bit, but there's even the potential for retrogression."

Lavin said China would lack a "road map for reform" after its World Trade Organisation accession process, which began with its admission in December 2001, is concluded this December.

He said he was concerned about Beijing's moves to cap foreign investment in a range of sectors viewed as contributing to the overheating of the economy, with growth reaching 10.9 per cent in the first half of 2006. The government has tried a number of ways to cool the economy, with little success, in part because it has failed to repudiate the need for rapid growth as the over-riding source of its own legitimacy -- and as the measure against which most officials throughout the country are routinely rewarded.

It doesn't want to raise interest rates significantly, or to let the currency trade up further than a few token points. It doesn't want to risk upsetting further the farmers -- the majority of the country -- who are everywhere instigating riots and other forms of protest in an uncoordinated-but-disturbing manner for a political party born of countryside agitation.

Its government is adamant that it doesn't need to do what uninvited foreigners tell it. The last leadership -- Jiang Zemin and Zhu Rongji -- focused strongly on international opening, joining the WTO, eagerly encouraging foreign investment, reaching $US 80 billion in 2005. But that was then, this is now.

When Robert Mundell, an economics professor for 32 years at Columbia University, New York, who won the Nobel Prize seven years ago, visited Beijing a few weeks ago as a specially invited guest, his advice was that a substantial revaluation or float would do countless damage to the poorer parts of the Chinese economy. He said China's huge foreign exchange reserves - heading towards $ US 1 trillion - were a more legitimate concern, best solved by more Chinese investments abroad and more Chinese consumption of imports.

Earlier in his academic life, Mundell demonstrated that no country could fix its own interest and exchange rates, while also allowing capital to flow freely. Of the three alternatives, Beijing's current favorite is to exercise more, not less, say over capital movements.

Some of the pressure has been taken off the government by the ease with which its biggest companies -- led, recently, by the Bank of China -- are able to raise massive funds from international investors almost, it seems, at will, via the Hong Kong equity market, without needing to give up political control of the companies and without needing to liberalize domestically, in the rest of the country.

If foreign companies want to increase their stakes in China, they will have to jump ever higher hurdles. On June 29, US retail giant Wal-Mart conceded the establishment of its first ever trade union anywhere in the world - in China's southern Fujian province.

It buys 1 per cent of China's entire gross domestic product annually, chiefly for its US stores. Within China, it operates 59 outlets, employing 23,000 people, and it plans to expand operations over the next five years to employ a total of 150,000. To be allowed to do so, it has bowed to the government's requirement that the All-China Federation of Trade Unions run its workforces there.

This is part of a broader picture. The chairmen of many leading firms in China are also now the party secretaries. And foreign companies and joint ventures are naturally falling into line.

Beijing doesn't feel it needs to court foreign companies to produce more exports. Already, exports comprise 70 per cent of China's gross domestic product, and 60 per cent of them are produced by foreign or partly foreign owned companies. The profit margins for most exports have become desperately thin, as input costs keep rising and as the pricing power of retailers, led ironically by Wal-Mart, keeps growing.

The International Herald Tribune published a study on August 4 about a Chinese factory, in Tianjin, that makes leather work boots. It sells them for $US 15.30 a pair, on which it earns a profit of 65 US cents. The US retailer sells them for $US 49.99 a pair, on which it makes a $US 3.46 profit.

An essay by State Council researcher Guo Yanying in China Economist, a glossy new magazine produced by the China Academy of Social Sciences, urges the country to abandon its export-oriented model of growth: "Instead of indiscriminately embracing all foreign investors, discourage foreign investment that brings low efficiency or even negative results. Urge domestic companies to increase in strength as quickly as they can. And nurture a contingent of large transnational enterprise groups." He says it's time to "change China's role in the sweatshop of the international division of work." And Lu Daodao, an economist with the Chinese Academy of Sciences, complains of the mindless pursuit of urbanization, which he compares with the disastrous Great Leap Forward of the 1950s and early 60s under Mao Zedong.

New policies are being put in place to reflect this shift. Among them is anti-monopoly legislation that does not affect the many strategic sectors where all business effectively remains state controlled, but does impinge on most of the areas where foreign firms are flourishing, such as soft drinks, film and construction equipment. In the past, foreign investors have been offered lower tax rates or tax holidays. That will now cease under the new policy of tax unification. China is also starting to insist on developing its own standards for new technologies, rather than seek to import the best of the rest of the world -- most emphatically with third-generation mobile phones.

China is at the same time starting to redirect its massive foreign exchange reserves from passive treasury holdings, chiefly in the US, into active corporate plays, aimed at securing access to strategic resources. For instance, China National Petroleum has just bought a $US 500 million stake in Russian oil giant Rosneft, while China National Offshore Oil Corp is busy investing in Asia and Africa, including recently buying a $ US 2.7 billion oil field in Nigeria.

Is China big enough and different enough to take its own route? Even if it doesn't end up succeeding as the exception to global rules, its leaders' very determination to do things their way is sufficient to take it on an interesting journey.

Rowan Callick is the Beijing based China Correspondent of The Australian.
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