China economy FAQ

Almost every day now, if you check Twitter, some founder or VC or journalist will have made the trip out to Shenzhen only to come back saying “CHINA IS SO AHEAD !!11!!1”. It’s hard to judge the veracity of these statements, since China and it’s economy seem so opaque to most people living in the West. People don’t even know where to start reading about it.

After a month or so of reading books and talking to people, here’s my “getting started” guide to learning about China. My aim with this blog post is to share general pointers that guide you where to look.

History and Background

For a broad description of the main differences between ‘Western’ societies and others, try reading about WEIRD psychology, the World Values Survey or the social impact of Christianity during the middle ages. The last book is good, because it explains the development of the concept of ‘human rights’.

China was a relatively isolated society until the 19th century, that saw itself almost as a world unto itself. The system of the Chinese emperor and mandarins had been in power for thousands of years. For the pragmatic mindset and cyclical view of history that evolved in this period, try The Art of War.

For a first encounter with the British “barbarians” — missionaries, diplomats and opium traders — in the 19th century, which eventually led to the fall of the Qing dynasty, try Imperial Twilight.

For the 20th century and Mao, Kissinger’s On China is the best, especially the first four chapters. It also serves as a useful general background on the other stuff.

Liberalisation and development

For background on the types of problems that face a state trying to liberalize it’s economy, see The Tragedy of the Anticommons and Blueprint for a Revolution.

From Third World to First, Lee Kwan Yeu’s account of his leadership of Singapore, is a thrilling account of modernising an Asian country.

For the tried-and-true development formula partially adopted by China after success in Korea and Japan, see the “East Asian Developmental Model”. This strategy has three main components

  • Land reform: breaking up large estates into smaller farmer-owned plots, which improves yields by giving farmers ‘skin in the game’. It also increases the ability of the state to tax farmers — it is politically easier to deal with many farmers than just a few
  • Export-driven manufacturing: export the surplus from farming, and use the new capital to buy industrial technology from rich countries. After establishing an industrial base, keep the economy export-driven — the global market provides greater incentives to get to the technological frontier than the domestic market.
  • Financial repression: the state typically uses a set of techniques control financial markets to ensure the newly created capital does not leave the country or become captured by rent-seekers. This includes things like capital controls and low-interest rates. Another technique is currency devaluation, which also serves to keep exports more globally competitive.

The Chinese Economy Today

Since Deng Xiaoping’s liberalizing reforms starting in 1978, China has developed from an agricultural economy to a fast-growing middle-income country. Chinese GDP per capita is around $8k, whilst in the much more developed cities, GDP per capita is around $20k (reaching $25k in Shenzhen). Official statistics claim China is growing at around 6% per year.

China’s economy is a blend of free-market capitalism and state-run capitalism. Part of this is the legacy of communism, but it is also driven by a pragmatic concern to maintain political stability whilst playing developmental catch-up. China’s state-owned enterprises (SOEs) dominate many of the critical sectors of the economy, such as natural resources, heavy industry or the military. Even for Chinese companies that are not state-owned, including the high-tech sector, it is common for the government to claim a seat on the board.

China is run by an authoritarian government, but in a very different way to the totalitarian systems of the mid-20th century. It’s an open question whether, as had previously been assumed by Western foreign policy types, the Chinese people will demand greater democracy and human rights as their country develops. Hong Kong protestors campaigned for greater liberalisation in 2014, and the movement is ongoing. Interestingly, many of the pro-liberalisation groups have a Christian background, and Christianity is growing rapidly in China, especially amongst women and in the coastal big cities.

Trade Wars

This piece by Kori Schake gives a good background on the rules of international trade, and the US-led international order. This piece by Christopher Balding describes how China has rejected many of those rules during it’s rise to power:

A rapidly growing China that respected liberal norms and rules would’ve been widely welcomed. Europe, the U.S. and Japan have all engaged in long-running disputes with each other, but they also share an understanding of what the rules are and an ultimate vision of more open markets. China doesn’t share that vision; in fact, it sometimes expresses contempt for it. This is the fundamental issue dividing the two countries.
Had Trump’s administration entered into negotiations on these grounds, it would’ve had significant leverage. Almost no other country shares China’s vision on these issues, and America’s many allies likely would’ve been willing to act as a united front if the U.S. were pursuing coherent goals.

The Chinese government claims the trade war is not about values such as human rights or free trade, but rather about the US championing it’s own interests above China’s need to develop. For an overview of how China sees the economic challenges it currently faces, and the biggest political economy issues for the Chinese government, read China’s Economy.

The race for technology

China has made massive advances in recent years, but is still dependent on other countries for key technologies such as airplanes and semiconductors. China’s ability to produce these technologies has geopolitical implications — if they have to buy from the US to keep their own products competitive, that gives diplomatic negotiating leverage to those countries.

Developing cutting edge semiconductors is a priority for the Chinese government, but it does not yet have the technical expertise necessary.

But perhaps the biggest long-term challenge for China is technology acquisition. Though the government would like to develop an industry from the ground up, its best efforts are still one or two generations behind the U.S. A logical solution would be to buy technology from American companies or form partnerships with them. That’s the route taken by cutting-edge firms in Japan, South Korea and Taiwan.
Yet China can’t do the same. Its efforts to purchase American semiconductor companies (often at huge premiums) are regularly blocked for security reasons. Japan, South Korea and Taiwan have put Chinese acquisitions under similar scrutiny. By one accounting, China has made $34 billion in bids for U.S. semiconductor companies alone since 2015, yet completed only $4.4 billion in deals globally in that span.

There is not only rampant industrial espionage and a growing competition for technical talent between the China and the US, but increased cross-border collaboration too.

China’s Take on the ‘New Economy’

Chinese tech firms such as Alibaba and Tencent are amongst the largest tech companies in the world. An ambitious young graduate in China, like in the West, will often either go into tech or finance. For these young people, tech is an exciting path to making a personal fortune. Many of them are somewhat nationalistic, and also see tech as a way to promote Chinese dominance.

Image result for china top tech companies

Some studies have shown most of cross-cultural variation in management outcomes is due to being able to reward employees based on performance, rather than seniority or other cultural factors. Within China, tech firms are known for being better run than most other companies. I asked someone in Hong Kong if management is fair enough within these big tech companies to let good ideas win — he replied that everyone in China is so used to playing politics in their daily lives, they can cope with sub-optimal management at work pretty well. (I guess, even the traditional game Go is about gaining a subtle, long-term strategic advantage.) Whatever the pitfalls of their management may be, it is still true that Didi was able to execute faster than Uber.

Chinese tech firms have grown incredibly quickly and have been seen as disruptive by ‘old economy’ firms. China is at the technological frontier for most consumer internet related technologies — I was told that China is especially strong at rapidly iterating and discovering new business models. An interesting example is the story of iQiyi, the ‘Netflix of China’, that uses a freemium model to finance new television.

The bearish case on these tech companies is that they have become especially large as a proportion of the Chinese economy, because their target consumers have limited options. As a result, they are able to grow much bigger and faster by ‘leapfrogging’ straight to the cutting edge.

By contrast, Western consumers are spoiled for choice, especially when it comes paying for things. They can use cash, credit cards, debit cards with major payment networks, checks, PayPal and, more recently, mobile payment systems such as Apple Pay. While mobile payments are gaining, the other payment providers are innovating as well. For the average consumer, there’s little difference between scanning a QR code and waving an RFID-enabled credit card at a specially enabled reader. And at least the card doesn’t require downloading and learning a new technology.
Similar examples can be found in other sectors as well. Alibaba has succeeded in large part because brick-and-mortar retailing is so challenging on the mainland. Roughly a quarter of the world’s cities with more than 500,000 people are located in China — twice as many as India, the next country on the list. Real estate prices in those urban areas are astronomical, which limits how big stores can be and thus the range of consumer choices.

Another reason to be bearish on Chinese companies is their limited appeal outside of China. If the Chinese tech ecosystem is closed off from the rest of the world, that makes it harder for it’s tech companies to be globally competitive. However, this is starting to change — Toutiao now has 10 million monthly users in Japan. The most notable success outside China is music.ly, which has 90 million users all over the world.

But US tech companies are facing problems outside their home country too. Google faces fines from the EU. Facebook has been in all kinds of trouble with foreign governments. The worse west coast companies are at diplomacy, the more likely Chinese tech companies are to expand abroad.

Belt and Road Initiative

In The Dawn of Eurasia, Bruno Maçães describes a new world order based around the continent of Eurasia. This is a similar vision to how China would imagine a world order of it’s own — with China at the centre, and the historic trade routes of the Silk Road re-established. Every hegemonic power remakes the world order in the image of it’s domestic politics, and it seems that is what China is doing with Belt and Road.

The programme is ambitious: over 7000 infrastructure projects are planned over 64 countries. Despite the steep cost, China is financing infrastructure for it’s neighbouring countries and the developing world, to further it’s geopolitical ambitions. Often these infrastructure projects are a way to claim important territory or natural resources. One example would be the project in Sri Lanka, that was used as an entry point to seize control of a port.

Conclusion

If China surpasses the US as a hegemonic power in the next century, that carries with it an high likelihood of war. The Thucydides Trap means that it is very difficult for a rising power to peacefully supplant an existing power. There is only one such transition in history — the USA replacing Britain as the leading power in the 19th century. An account of that handover can be found in the short book Safe Passage.

The rise of China is an important and fascinating topic, and one I don’t think tech people are paying enough attention to. The people tasked with peacefully managing China’s rise seem to not to be that familiar with tech (hence the endless pieces about countries ““““investing in AI””””), so it would probably help if tech people were more informed and communicated more on these issues.

If I had to boil it down to two recommendations, read this short piece about living in China by an expat libertarian professor. And then read China’s Economy.