A Note on the Middle Income Trap

In the last couple of years, a number of China political observers have commented on the dangers to China of the middle income trap. The fear is that the Chinese economy will fall into the trap. Since economic growth is the remaining claim to legitimacy for CCP, a substantial slowdown from real growth rates of 6 to 15 per cent per year, which obtained in the last forty years, will be disturbing to the harmony that keeps CCP in power.

In what follows I am not making direct claims for or against the middle income trap in China, only describing the concept.

What does the middle income trap mean?

Most models of national development posit a growth track that demands –

– increased savings, so savings can be used for investment;

– an abundant low wage population;

– transfer of low wage, low productivity workers into higher productivity jobs in factories;

– promotion of exports; and

– a progression to higher levels of productivity, eventually approaching the GDP per person levels of the most developed countries.

Only a few countries – notably, the Asian Tigers – Singapore, South Korea, Taiwan, Hong Kong – have made that transition. More countries have begun the transition and after a couple of decades, found themselves stuck – unable to significantly increase GDP per person. That list is longer – Mexico, Philippines, Malaysia, Indonesia, Turkey. The World Bank has identified 37 countries that are prisoners of the middle income trap. These countries have achieved middle-income country status, but seem unable to pass that barrier, or trap.

It is important to note that the middle income trap does not mean people are starving, or in poor health. It does not mean that economies are failing, only that GDP/person is failing to grow much. National economies are stuck, not declining. But notably, economic performance is the remaining claim to legitimacy for CCP, now that Marxism-Leninism is discredited (except for Mr. Xi) and nationalism is a dangerous ally. If nothing else, the middle income trap may be just reversion to the mean of GDP growth. But that alone is scary for a government whose claim to legitimacy is growth.

Reasons for the middle income trap include the need to transition institutional arrangements, from those that worked well when the country was emerging from poverty to those needed for higher quality growth – one can imagine changes in rules about finance, banking, savings, property ownership, transfers of ownership, control of bribery and corruption. With increasing sophistication of work come demands for increasing sophistication of education – workers in finance need different training than workers on factory assembly lines. Also, changes in cultural features – attitudes to education, health care, family connectedness. Acemoglu and Robinson in Why Nations Fail boil most of the necessary changes down to institutional change – rules, regulations, laws, customs built in to culture.

Is there evidence for the middle income trap in China? Here are some things that keep Chinese macroeconomists up at night.

Scott Rozelle, education and health researcher in rural China, defines part of the problem, not mentioned in glowing reviews of Chinese economic power. In decades of research across many Chinese provinces, he finds that iron deficiency anemia was present in 40% of students in fourth and fifth grade in at least four rural provinces; in Guizhou and other southern provinces, 50% of children suffered from at least one type of intestinal parasite; and nearsightedly was common in schoolchildren, but went unaddressed in many rural areas. Health care and education in rural areas is now significantly better than twenty years ago, but problems persist for much of the rural population. The health problems are definitely treatable; but they persist, nevertheless. Rozelle has found that 15% to 20% of rural kids do not do not complete middle high school. That is a fearful statistic for future growth. Many of those same kids are affected by poor quality or poisonous drinking water, or rice laden with heavy metals, or air that is even more poisonous. China has been a leader in flashy environmental projects – wind, solar, dam construction. Not so much in the unflashy, dirty job of cleaning air, water, land, or ensuring food quality. Spending on those items will make no contribution to exports or factory technology or even short term health. For local officials, what’s the point?

For those rural kids, China now has much less ability to build on exports to fuel internal growth. The rural school children who don’t go to high school are not going to swing investment deals in London, and other countries in Asia and Africa are now lower cost producers of commodity and low-end products. That part of the growth path is now less available in China for the 800,000,000 or so who are not middle class and living in Beijing or Shanghai or Hangzhou. How will they flourish?

That is one side of the problem. Another side is the ability of superior Chinese scientists and engineers to continue with indigenous innovation. In one sense, this is not a problem – what is not invented can be stolen, as in the past. But innovation is no longer an individual working in his garage, but coordinated lab work and bench work and computer work, and collaboration with people outside China is vital. The Great Firewall, in all its manifestations, inhibits that. On a project basis, that may not be much of a problem. In addition to theft, direct internet access to western journals and scientific reports in readily available within scientific and engineering schools and labs. The firewall, which is eminently adjustable locally, does not affect them. On another level, however, those same scientists and engineers can find themselves unable to participate in the events of the world in which they have an interest – conferences and symposia and simply news of family and friends outside China. Sometimes, these sophisticated workers find the daily restrictions and requirements – writing paeans to Xi Jinping Thought, as is a current requirement – to be just too stupid, and they leave. They don’t want their kids to write such paeans, either.

When we look at the macroeconomic picture of China is all its glory and warts, we come down to the Acemoglu and Robinson prescription – institutional change. The change required is not small. It is systemic, and at the heart of the Chinese model for the last forty years – financial repression and investment in infrastructure and real estate. Interest on savings in banks was held low, so loans to SOE and other factories and real estate developers could be held low as well. The hukou kept peasants out of cities, keeping social overhead capital for poor people – primary and secondary education, health care, low income housing, pensions – mostly out of government budgets. But changing the model means changing the relative shares of income in the economy – poor people and farmers and ordinary savers need to get a larger share of total income, and lots of vested interests in government and SOE and banks need to get a smaller share. The reluctance to share in China is no less than it is on Wall Street, hence the political conundrum. Social spending in China on education and health care and pensions needs to go up significantly, as China ages and education needs are greater and pensions, long a source of misspent and stolen funds and poor accounting, become a bigger factor in people’s lives.

Truthfully, when reform began in 1978, China did need every piece of infrastructure that it could build – trains, planes, airports, ports, expressways, housing, factories, offices. Now, what was needed is built, and far more. The return to GDP from more construction is less and less. That contributor to GDP growth is no more. But building more stuff is the only lever that officials have right now to goose short term GDP.

Finally, the world is no longer cooperating with China. For forty years, in the US and Europe, policy makers were willing to accept some job losses in return for low priced consumer goods. Now, in 2019, governments are less willing to trade jobs and technology for low priced shirts and televisions. That is one threat facing China. Another is the economic construct of a secular stagnation, a general slowdown in all the advanced economies attributable to ageing populations (which don’t buy as much), greater income disparities (since the wealthy don’t simply buy more food or shirts or televisions), greater savings in advanced economies (due to risks of recession or simple job loss), and even greater flexibility in wages and prices, which we normally think of as a good economic outcome (flexibility can increase savings and decrease spending because incomes can now fall as well as rise). In general, there is more savings than the world can profitably use, and investment levels remain anemic. This is certainly not good for China exports or profitable Chinese infrastructure investments overseas.

There is no guarantee that GDP/person will fail to grow in China. But the threat is there, as evidenced by the paper by Barry Eichengreen, Donghyun Park, Kwanho Shin in 2013 – Growth Slowdowns Redux: New Evidence on the Middle-Income Trap. Their conclusion – We also find that slowdowns are less likely in countries where the population has a relatively high level of secondary and tertiary education and where high-technology products account for a relatively large share of exports, consistent with our earlier emphasis of the importance of moving up the technology ladder in order to avoid the middle-income trap.

That is what CCP theoreticians and macroeconomists are thinking about.

Huawei – Lie down with dogs, get up with fleas

You know the meme – when you work with bad guys, you should expect to be labeled a bad guy. I mean no disrespect to the thousands of Chinese companies doing business across the world that manage to be profitable without intimate Chinese government relations. But in our globalized, internet era, it is impossible for a high tech company, particularly one as fundamentally important to internet networks, to not be tarnished with the specter of theft of intellectual property and CCP internet control and monitoring of Chinese businesspeople, students, even foreigners.

Probably no one outside a small group of analysts has the actual evidence of real dirt on Huawei. But that is the risk of being a national champion in China. If the government is promoting you, then there must be a government interest in promoting you, beyond just “go team.” This is simply Chinese practical reasoning.

But it seems that lying down with dogs is more than just a saying here. In his extraordinary Sinocism news blog, Bill Bishop continues the Huawei stories. From the February 9 edition, with no repetition in the stories (all should be clickable) –

1. Huawei’s bad start to the Year of the Pig

Trump likely to sign executive order banning Chinese telecom equipment next week – POLITICO:

President Donald Trump is expected to sign an executive order, banning Chinese telecom equipment from U.S. wireless networks before a major industry conference at the end of February, three sources told POLITICO.

The administration plans to release the directive, part of its broader effort to protect the U.S. from cyber threats, before MWC Barcelona, formerly known as Mobile World Congress, which takes place Feb. 25 to Feb. 28.

Mobile network operator’s body GSMA considers crisis meeting over Huawei | Reuters:

Mobile communications industry body GSMA has proposed its members discuss the possibility that Chinese network vendor Huawei [HWT.UL] is excluded from key markets, amid concerns such a development could set operators back by years…

GSMA Director General Mats Granryd has written to members proposing to put the debate around Huawei onto the agenda of its next board meeting, a spokesman for the federation told Reuters on Saturday.

The meeting will be held in late February on the sidelines of the Mobile World Congress, the industry’s biggest annual gathering, in Barcelona.

Trump envoy urges Europe to ‘link arms’ against China – POLITICO:

Describing China’s influence as “malign,” Gordon Sondland, the U.S. ambassador to the European Union, told POLITICO that his country and the EU should overcome their current trade tensions and join forces against the Chinese.

“We should … combine our mutual energies — we have a $40 trillion combined GDP, there is nothing on the planet that is more powerful than that — to meet China and check China in multiple respects: economically, from an intelligence standpoint, militarily,” he said in an interview.

“That’s where the EU and U.S. really should be linking arms,” Sondland continued, advocating for “a quick resolution that would move our trade relationship in the right direction so that we can both turn toward China, which is really the future problem in multiple respects.”

Huawei Deals for Tech Will Have Consequences, U.S. Warns EU – Bloomberg:

“There are no compelling reasons that I can see to do business with the Chinese, so long as they have the structure in place to reach in and manipulate or spy on their customers,” Ambassador Gordon Sondland, Trump’s envoy in Brussels, said Thursday in an interview. “Those who are charging ahead blindly and embracing the Chinese technology without regard to these concerns may find themselves in a disadvantage in dealing with us.”

Huawei representative rebukes US ambassador’s accusation, defends integrity and safety – China Daily:

“Recently, Huawei has been under constant attack by some countries and politicians. We are shocked, or sometimes feel amused, by those ungrounded and senseless allegations,” said Abraham Liu, Huawei’s vice-president for the European region and chief representative to the EU institutions.

“For example, yesterday, the US ambassador to the European Union, Mr (Gordon) Sondland, said (that) someone in Beijing (could) remotely run a certain car off the road on 5G network and kill the person that’s in it. This is an insult to people’s intelligence, let alone the technological experts across the world,” Liu said.

Chinese firm Huawei blocked from ‘sensitive state projects’ and 5G amid security concerns-The Sun:

New laws on foreign investment in the UK will block Chinese firm Huawei from sensitive state projects, The Sun can reveal… senior Cabinet ministers and Britain’s most senior civil servant Mark Sedwill fear Huawei’s involvement in such critical infrastructure could jeopardise national security.

They are planning reforms to allow the Government to ban Chinese firms like Huawei from future involvement in “strategically significant” UK tech projects.

Huawei Says U.K. Software Issues Will Take Years to Fix – WSJ $$:

The telecom giant also said in a letter to the U.K. Parliament that its board of directors has signed off on a companywide overhaul of its software engineering, budgeting $2 billion over five years for the effort..

German ministers meeting to discuss how to deal with Huawei in 5G auction: source | Reuters:

Chancellor Angela Merkel said on Tuesday that Germany needed guarantees that Huawei would not hand over data to the Chinese state before the telecoms equipment supplier can participate in building its 5G network.

German newspaper Handelsblatt said Wednesday’s meeting would focus on whether a security catalog, prepared by the Federal Network Agency and the cyber defense agency (BSI), along with certification rules and a no-spy agreement with China, would be enough to ensure future 5G mobile networks are safe.

Norway’s PST warns against Huawei – Newsinenglish.no:

Justice Minister Tor Mikkel Wara of the Progress Party, who joined Bjørnland at Monday’s PST briefing, later announced that measures would be introduced to reduce the vulnerability of the Norwegian network. The goal is to hinder Norway’s large mobile operators Telenor, Telia and Ice from choosing equipment suppliers that could threaten the nation’s and their users’ security. Huawei is the prime target.

China hacked Norway’s Visma to steal client secrets: investigators | Reuters:

Hackers working on behalf of Chinese intelligence breached the network of Norwegian software firm Visma to steal secrets from its clients, cyber security researchers said, in what a company executive described as a potentially catastrophic attack.

The attack was part of what Western countries said in December is a global hacking campaign by China’s Ministry of State Security to steal intellectual property and corporate secrets, according to investigators at cyber security firm Recorded Future.

China says it is not a threat to Norway, denies cyber espionage | Reuters:

“China poses no threat to Norway’s security. It’s very ridiculous for the intelligence service of a country to make security assessment and attack China with pure hypothetical language,” the Chinese Embassy in Oslo said in a statement on its website.

Huawei Threatens Lawsuit Against Czech Republic After Security Warning – The New York Times:

The warning, which carries the force of law, requires all companies in the Czech Republic that are deemed critical to the nation’s health to perform a risk analysis that takes security concerns into account.

China denies ‘ridiculous’ spying allegations by Lithuania | AFP:

Earlier in the week, two Lithuanian intelligence agencies condemned China for an “increasingly aggressive” spy campaign, which they said included “attempts to recruit Lithuanian citizens”.

Darius Jauniskis, head of Lithuania’s State Security Department, said his agency was analysing the potential “threat” posed by Huawei, whose technology is being used to build the EU and Nato state’s new 5G telecommunications infrastructure.

Huawei offers to build cyber security center in Poland | Reuters:

Italy denies it will ban Huawei, ZTE from its 5G plans | Reuters:

Thailand launches Huawei 5G test bed, even as U.S. urges allies to bar Chinese gear | Reuters:

University of California Berkeley bans new research projects with Huawei after US indicts Chinese telecoms giant | South China Morning Post

Stanford halts research ties with Huawei amid surveillance controversy – The Stanford Daily

Vermont phone carriers in dispute over concerns about Chinese firm Huawei – VTDigger

2. FBI raids Huawei’s San Diego offices

This is a damning story. One argument some defenders of Huawei have used is that the firm’s culture has changed since inception and while it committed an “original sin” of IP theft in its early years now that it is a global tech firm its behavior has changed. This story destroys that argument.

Huawei Sting Offers Rare Glimpse of U.S. Targeting Chinese Giant – Bloomberg:

Diamond glass could make your phone’s screen nearly unbreakable—and its inventor says the FBI enlisted him after Huawei tried to steal his secrets…

The first sign of trouble came two months later, in May, when Huawei missed the deadline to return the sample. Shurboff says his emails to Han requesting its immediate return were ignored. The following month, Han wrote that Huawei had been performing “standard” tests on the sample and included a photo showing a big scratch on its surface. Finally, a package from Huawei showed up at Gurnee on Aug. 2. ..

Shurboff says he knew there was no way the sample could have been damaged in shipping—all the pieces would still be there in the case. Instead, he believed that Huawei had tried to cut through the sample to gauge the thickness of its diamond film and to figure out how Akhan had engineered it. “My heart sank,” he says. “I thought, ‘Great, this multibillion-dollar company is coming after our technology. What are we going to do now?’”..

The FBI raided Huawei’s San Diego facility on the morning of Jan. 28. That evening, the two special agents and Assistant U.S. Attorney Kessler briefed Khan and Shurboff by phone. The agents described the scope of the search warrant in vague terms and instructed Khan and Shurboff to have no further contact with Huawei.

———-

It is an old truism that China tends to be tone deaf in dealing with foreigners, particularly on foreign policy issues. So we find no small sense of irony in the story from Reuters last week Huawei Offers to Build Cyber-security Center in Poland – “China’s Huawei has offered to build a cyber security center in Poland where last month authorities arrested a Chinese employee of the telecommunications firm along with a former Polish security official on spying charges.”

One of the stories circulating in the past couple of years is that Huawei might have stolen some technology early in its life, but those days are over now, all is in the past, now we are in a new era. Stories from the bad old days – In 2002, Cisco Systems Inc. accused (Huawei) company of stealing source code for its routers. Motorola said in a 2010 lawsuit that Huawei had successfully turned some of its Chinese-born employees into informants. And in 2012 the U.S. House Intelligence Committee labeled Huawei a national security threat and urged the government and American businesses not to buy its products. Huawei denied all the claims. The Cisco and Motorola lawsuits ended with settlements.

For anyone still unsure of the extent of Huawei espionage or theft, there is this Bloomberg story – Huawei Sting Offers Rare Glimpse of the US Targeting a Chinese Giant. This story is about a small American company creating a “diamond glass” computer screen that would be stronger than anything now on the market. The diamond glass story is about an IP theft from last August.

The detention of Meng Wanzhou, originally on charges of violating economic sanctions against Iran by using a shell company to get around restrictions, now seems less of a political stunt. From the Chinese foreign ministry – “For a long time, the U.S. has used state power to smear and attack certain Chinese companies in an attempt to stifle legitimate business operations … Behind that, there is strong political motivation and manipulation. We strongly urge the U.S. to stop unreasonable suppression of Chinese companies, including Huawei, and treat Chinese enterprises fairly and objectively.”

Un huh. One can only hope that Huawei is not treated as “fairly and objectively” as Trump treated ZTE.

Idle Thought – last week in January, 2019

What if this past weekend were the beginning of the end for the orange haired baboon? And, in the process, the GOP were so damaged that even a Pence presidency couldn’t do much harm, and we gained a president in 2020 who was smart, thoughtful, respected intelligence and loyalty to allies and was up for repairing the extraordinary damage, domestic and international?

Someone who might say something that would remind us of these lines –

“Let the word go forth from this time and place, to friend and foe alike, that the torch has been passed to a new generation of Americans, born in this century, tempered by war, disciplined by a hard and bitter peace, proud of our ancient heritage, and unwilling to witness or permit the slow undoing of those human rights to which this nation has always been committed, and to which we are committed today at home and around the world. Let every nation know, whether it wishes us well or ill, that we shall pay any price, bear any burden, meet any hardship, support any friend, oppose any foe to assure the survival and the success of liberty.”

Suppose we looked back on the past two years, or three, as having fought and emerged from a great conflict, knowing that the alternative was always looking us in the face, that if we had failed no one would never hear the American version –

… then the whole world, including the United States, including all that we have known and cared for, will sink into the abyss of a new dark age made more sinister, and perhaps more protracted, by the lights of perverted science. Let us therefore brace ourselves to our duties, and so bear ourselves, that if the British Empire and its Commonwealth last for a thousand years, men will still say, “This was their finest hour.”

And in an inaugural speech in January, 2021, we might hear echoes of –

With malice toward none, with charity for all, with firmness in the right as God gives us to see the right, let us strive on to finish the work we are in, to bind up the nation’s wounds, to care for him who shall have borne the battle and for his widow and his orphan, to do all which may achieve and cherish a just and lasting peace among ourselves and with all nations.

Good luck to us with that. How would that sit with all the tinpot dictators who have sprung up in the last five years, and their beleaguered people? And how would that sit with all those in Africa, and the –stans, and South America, who have looked hard and trembled at rapacious lending of China and the prospect of Chinese internet, Chinese censorship, Chinese media, Chinese rule of men, Chinese tribute, wishing for an alternative that left them some dignity?

Oh. And Reagan on walls –

“Rather than talking about putting up a fence, why don’t we work out some recognition of our mutual problems, make it possible for them to come here legally with a work permit,” he said. “And then while they’re working and earning here, they pay taxes here. And when they want to go back they can go back.”

https://www.mercurynews.com/2018/12/21/analysis-heres-what-reagan-actually-said-about-border-security/

And –

“I’ve spoken of the shining city all my political life…in my mind it was a tall, proud city built on rocks stronger than oceans…with people of all kinds living in harmony and peace; a city with free ports that hummed with commerce and creativity. And if there had to be city walls, the walls had doors and the doors were open to anyone with the will and the heart to get here. That’s how I saw it, and see it still.”

https://www.azquotes.com/quote/547667

Update on Peking U Ideological Battle

January, 2019

In a recent post, The Ideology of Occupation, I described an ideological struggle being played out last month at Peking University, the combined Harvard-Yale of China. Now, a followup on what has happened to the “Old Marxist” students who questioned the manner in which CCP has been providing leadership of the proletariat. Spoiler – they are in jail.

Bill Bishop has the story at Sinocism – Seven Maoist Students Detained in Beijing After Talking to Foreign Media Original story from Radio Free Asia. A video was made by Peking student Zhang Ziwei immediately before he was himself detained –

“I’m Zhang Ziwei,” the recording says. “Six of my classmates have been detained already today, two of them just downstairs from where we live.”

“They were shoved into a car, shouting ‘call the police!,'” Zhang says, adding that he too is a target.

“Dark forces are conducting house-to-house searches right now,” he says. “They want to take me away too, just like they did to the others.”

It appears that the “Old Marxist” students have been not only defeated, but jailed. Their support for the Marxism of class struggle is out of date in the modern China of Xi Jinping.

I am reminded of the climactic scene in the movie A Few Good Men in which Colonel Jessup (Jack Nicholson) rages against the upstart attorney Lieutenant Kaffee (Tom Cruise). In the setup, the Colonel is standing on the wall, battling the forces of evil, while Kaffee and his cohort stand for rule of law and honor to regulations and tradition, properly understood. Jessup rages against Kaffee and colleagues for questioning the manner in which Jessup stands on the wall – You Can’t Handle the Truth. You know the scene, and how it ends. Jessup claims a greater responsibility than Kaffee can imagine. So, too, at Peking U. In this Peking University struggle, the New Marxists are the forces of modernity, standing on the wall and battling the forces of western imperialism and western thought and western concepts. CCP will determine what socialism and Communism means, and there can only be one source of truth. There is no questioning of the manner in which CCP provides leadership. In the Chinese version of the movie, Jessup would be exonerated and honored. The “Old Marxist” students, representing the outdated western import of Marxism, can’t handle the truth.

An Evening in Middle Class Life

October, 2009

There is a pattern in the west of seizing on negative China stories as definitive proof than revolution, or collapse, or the Second Coming are just around the corner. Debt and moral vacuum and lack of trust and cheating. But China is a big country, with a big middle class that is vested in ongoing stability. This is just a dinner story from ten years ago, with government friends from Hangzhou and Shaoxing. This is just middle class people relaxing and enjoying the holiday.

This story is also about middle class CCP members, and such an observation seems sorely overlooked in most discussions of China’s future. I have no systematic data, but my educated guess is that a Venn diagram of Chinese middle class – however you wish to define them – would show great overlap with CCP membership. There are about 90 million CCP members. With some dual member households, let’s speculate that comes to 60 million households. These are the people holding nearly all government jobs, heading up non-government organizations, teaching in high schools and universities, and owning many small and large businesses. Let’s give those 60 million households one child and a grandparent or two, or four, and that is roughly the same as the size of the middle class. CCP is the middle class, and when writers talk about emerging democracy and civil society and middle class demands for voice, we should remember who we are talking about. The CCP is the bourgeoisie.

I went to dinner last night at Jennifer’s apartment, with Stone, and James, and Morgan, and Shelly from Shaoxing. Alice was there too. Jennifer and her husband and son live in one of the new developments on Zijinghua Road, just past the xixi wetland national park and about fifteen minutes from ZUST. Like many or most new developments in China, this one is gated, with a seven foot high wall at the perimeter. There are problems with burglary in china, not so much robbery, but historically towns and developments of all kinds have been enclosed, in a cellular pattern, so gated communities now are partly for security but also a historic design legacy. Since this is a pretty fancy development, and mostly for government people, there are two uniformed guards at the gates, who check for who you are visiting and act as building doormen for the residents- get this package, give directions to your aunt when she comes visiting, tell the plumber where to go to find your apartment when he comes to fix the toilet.

Like most any new development, this one is very big. I don’t know the number of buildings- I will say, thirty- a mix of four story walkups with others, surrounding a driveway that curls around behind buildings and leads to an underground garage, as well as a fair amount of parking at grade level adjacent to the buildings. The landscaping is pretty, bamboo and rocks and other green stuff, not as extensive as at some projects where there is no at grade parking, but still thoughtful. There is a community building which has a dining room and a party room, and a slightly raised agora, with stone and landscaping that serves as a meeting point – “meet me at the agora in ten minutes.” Buildings are close together- the driveway is really one way, except in a couple of places where it doubles back on itself, and the feeling is that of close-knit, though expensive, community. In the short two way driveway from the gate to the buildings, there are eight or ten small stores on each side of the street, on the first floor of the first two buildings. A fruit stand, a dry cleaner, a grocery store with a few more essentials, I think an insurance office. Think self-contained and walkable and low stress and low key. The world is outside and tense, not far away, but inside, the tension melts. At least that is what I saw.

Jennifer’s family has the top floor and the fifth floor finished attic, really another entire floor, of a four story walkup. The apartment has all the tricked out stuff typical of an middle American family with a ten year old boy. The big screen tv set to video games of wii tennis, or baseball, or badminton. Soccer ball in the corner, which we used a little in the dining room. (I can beat the ten year old, no problem). Plastic basketball net set up facing out from the middle of the railing on the stairway to the fifth floor, at about six feet high. The kid is a good shot from behind the dining room table, but it is his court. And he seldom has to drive past somebody twice his size, so I was able to hold my own.

Stone, who is an administrator at a college about an hour away from ZUST but still in Hangzhou (east of the river and the Hi-Tech Zone) picked me up at school. When we walked in to Jennifer’s apartment everybody there was already making dumplings. Alice joined in, and this was her entre to the Hangzhou group from one year later at IIT. You know that many city governments send people to IIT each year, some from the same departments each year, but the group loyalty is to the group that comprises your year, not the group from your city. So Shelly, from the same year as Jennifer in Chicago, was Alice’s contact to get invited to this dinner. But Alice was making dumplings with everybody else, and chatting away, and this is one way to get accepted into the group. If I were crude, I would say it was sort of like dogs sniffing to see if the new person acceptable. Everybody laughed at my attempts at dumpling making, which was fine. Some of theirs, notably some of the guys, were not too great either, but my job is to be the clumsy foreigner.

Jennifer’s inlaws cooked dinner. In a way I have seen repeated many times, the parents cook, behind the closed parting doors to the kitchen, which are standard because so much Chinese cooking involves oil, and frying, and fish, but do not join us for dinner. Dinner the usual- big cherries, not from China, but probably from Australia, maybe US, she said. (Prices on cherries are down a little from the peak of spring festival. At the peak, they were 65 rmb a pound, she said, which even if she meant a kilo, is still pretty expensive). Everyone said they missed the prices on cherries in the US. Big strawberries. Little shrimps, which are easy to eat if you pull off the heads and the rest of the shell comes away easily. Chinese are able to dismantle the shells in their mouths with their tongues, which must under different circumstances be a great comfort to Chinese women. A fruit like a grape, but with a tough skin that must be peeled, but is good. Of course, the dumplings we all made, by the dozens, when we got to the apartment, and is a source of much community building. A shared food making experience that everyone’s ancestors did. Dumplings are what you eat at the beginning and end of an event, so this was standard end of spring festival fare. Also, since it was Lantern Festival day (eve, actually), we had fish balls, which are not nearly so repulsive as they sound. A little sweetened dough with a little bit of tasty fish wrapped inside the ball, cooked for a moment. Cabbage and mushrooms, and chicken feet and …. corned beef. Also specially treated pork, that Jennifer confessed to buying frozen, because it is better than she could make herself, but was tasty with a dark sauce and lots of darker meat. Alice brought a flagon, I think is the word, of Shaoxing rice wine, which is only from Shaoxing, and is famous, and is tender and drinkable without being sweet or killer in aftereffect, and is the head fake drink that Linda, one of our government students in Chicago, sometimes drinks to get through the nights of business dinners and drinking (One Third Coke, Two Thirds Sprite) in Shenyang, a thousand miles away. When she is not surreptitiously mixing coke and sprite.

Fireworks on National Day

After dinner, the ten of us or so went downstairs to the agora. Morgan had brought several boxes of fireworks, and tonight was the last night to set off fireworks during the spring festival. Morgan and Stone were in charge of placement of the skyrockets and firecracker strings. They placed some, held others in reserve. Several of us took turns lighting the rockets, which were bursting in air just like in the song. Not too high, maybe three or four stories, but pretty and loud and smoky and fun. We stood around, talked, some other people stopped with their two year olds, and watched, others went about their business. The other apartment buildings were not more than 30 or 40 yards away, but no one was yelling out the window or calling the cops or fussing at us. Given the age of Jennifer and Morgan and the other students, you have to think of our parents at age 35 or 40, in the backyard with the neighbors, shooting off fireworks in 1955 or 1960. Everybody the same age, everybody the same situation, including having parents live with them, everybody pretty happy to be where they are, everybody happy to let someone else be happy. It is true that fireworks in china are part of the culture, and it certainly is true that I do not see a lot of what I am looking at, but I am telling you what I did see. There is a lot of paper and mess to clean up after a fireworks display, but we did not have to worry about that, presumably because the cleaning people would be there in an hour or tomorrow morning to take care. It is part of the deal. They would do a good job on the cleaning, because that was their job.

A digression- there is a lot of writing and observation about how difficult it is to get Chinese to work. Response to instructions is literal, and no one does more than minimally acceptable. The Chinese version of the Russian, “we pretend to work and they pretend to pay us.” I see some of the literalness in students, and some of the mule mentality – “we will work if you beat us” thing. Maybe the positive side of that description is that people respond to incentives, and maybe the literal instruction is “pick up every visible scrap of paper you see,” but I have a hard time reconciling the mule mentality with the cleanliness of the agora as I know it will be tomorrow. Maybe having to work is a great incentive- the cleaning people are never twenty or thirty years old, but look to be seventy. Though they might only be forty.

The evening stroll

After the fireworks, we walked toward the front gate, Jennifer chatting with a couple of neighbors on the way. it is fascinating to see Jennifer this way. In Chicago, she was the academic monitor of the Zhejiang students – the person in charge of making sure schoolwork got done and serving as liaison with the school faculty. My image of her was always this nice, not overdressed, but nicely dressed and together but tightly wound woman with a friendly but still Chinese seriousness about her. Like she understood everything, just her range was intentionally limited. Anyway, here she is in slightly faded jeans that are a little worn, and a floppy grey sweatshirt, and tennis shoes, and she looks relaxed and happy and the entire group of us is just a bunch of friends going for a walk after dinner and fireworks. No agenda, no face, no guards. I kid Jennifer that my one hope in China is that some night I take her out to some jazz club on Nanshan Road, and by the end of the night see her dancing on the table. But with this Jennifer, the one last night, that does not have to be the hope anymore. This is hostess Jennifer, and mom Jennifer, and daughter Jennifer, and wife Jennifer, and friend and colleague Jennifer, and the package is so much more interesting than the IIT academic monitor Jennifer.

We walked a few blocks down Zijinghua Road, to Wen’er Road and Xichen Square, name of a neighborhood and a retail district. There is a big department store I have been to a couple of times, and next to it is the actual square. Nothing too fancy, just a fifteen foot tall sculpture to the moon month goddess, and a flat square surrounded on two sides by apartments and one by the department store. The department store has a pizza hut and KFC on the first floor, and both are crowded. This is Saturday night, so the KFC is busy. That means that there are five lines of customers to place orders, each line four or five people deep. Not because the busload of tourists from Naperville just arrived. This is everyday busy. Upstairs from the KFC and Pizza Hut is the strategically located health club.

We stopped and got ice cream at KFC for Jennifer’s son and his buddy, and walked over to the square, which was fitted out with a bunch of displays, all about celebrating New Year’s year of the tiger and spring festival. There were stands selling huge amounts of cheap Chinese junk- the same stuff we buy at street fairs and at the beach- the colored trinkets that spin, or blow in the wind, or pop up and down, or just look pretty, or colored light sticks. We thought there would be fireworks at the square, and maybe there were later, but we left after about 45 minutes and a bunch of pictures of us together in front of the big plastic and paper tiger than moved its head and body on a small motor. We could have stayed, but I think Alice and Shelly had to get back to Shaoxing, which is about 90 minutes away, and Alice had kept her driver the whole time in Hangzhou, so she wanted to give him a break and let him get home to Shaoxing before midnight.

We walked back to Jennifer’s apartment, past her son’s grade school, and past several other restaurants and apartment buildings. It was a beautiful February night, about centigrade 10 or 12 degrees, so you needed a jacket, but no scarf or gloves or hat. There were lots of people out, and stores were all open, and traffic moved, and couples walked by holding hands, and couples were out with their kid, and if you tell me that the entire chinese economy is a ponzi scheme, and will collapse next week, well, you have to account for the incredible normality of daily life. I suppose we could be sitting in the eye of the hurricane, but the burden of proof is going to have to be on the extreme skeptics. Can there be slowdowns in growth? Can real estate prices drop some, and construction take a tumble, along with local government revenues? Can there be news stories about why didn’t we see this coming, and who do we blame, and what do we do now? Can the PBOC have to step in and recapitalize some banks? Can the central government have to restructure fiscal relationships with the provinces, to bail out provincial and city developments? Can a mountain of debt be a problem for China, too? I just don’t think Xichen Square is going away, nor the KFC, nor Jennifer’s apartment complex or lifestyle. Michigan Avenue is still there, and stores are still open, and I bet the beach will be crowded on a hot day in July, when I come back. We have very tough times ahead in the US, but I don’t think we are going to look like 1932, and there can be tough times ahead in China, but most everybody will weather the storm. There is a big differences among a financial crisis, an economic crisis, and a depression. There is froth in the financial and real estate markets in China, and that will lead to a tough financial crisis and a minor economic crisis at some point, but it will be contained, because of the ability of the government to act and because past growth, real estate excepted, has been based on realities, not hyperbole. Yes, the infrastructure may be too advanced to suit the economy (an argument I have heard made by some macroeconomists, and which I get but I think is wildly academic in this case), and there will be some empty office buildings, maybe a lot of empty office buildings, and the apartments are empty because Chinese are long term investors, so the crisis from a drop in apartment prices will be confined to developers mid project and to a few individuals who will need the cash, but their units will be snapped up quickly, and the office space crisis will be limited to the owners, some of which are SOE, who will be bailed out, and when the economic conditions change, the migrant farmers can go back to the farms in the rural provinces, where the government is already building infrastructure and encouraging FDI, and some loosening of investment laws will unleash the next wave of consumer-driven investing and spending in China, so some power shifts will take place. (Another digression – I disagree now with these early speculations about the Chinese macroeconomy. That is another story. I leave these observations as they were made in 2009 to remind myself of how radically different my own views are now.)

I know, I know- I am seeing Jennifer’s China, not the China of 800,000,000 peasants, but the people in Xichen Square are not all of Jennifer’s lifestyle, but they are there anyway, and the Chinese Dream is well and alive throughout China, I think, so the government has a couple of generations to make good on its promises, riots and disruptions and google and corruption on land taking and blocking of facebook and persecution of activists figured in. This is by no means a perfect society, Jennifer’s lifestyle notwithstanding, but it is not fragile and not going to hell in a handbasket. It is 5,000 years old, with pretty much everyone the same culture, and zero history of democracy, and a cultural expectation that the government will provide, which it gladly does, cynically if you wish, to keep the powers that be the powers that be. With the legal ability to protest, and strike, and democracy, and far worse metropolitan conditions relatively than in China, and far worse economic prospects for the next decade, the government in the US seems able to buy off those damaged by the crisis with some references to capitalism and free markets and hope and making sure everyone is tuned in to American Idol or the next blonde teenager disappearance national crisis. Somebody ask Lubet what he thinks about the status of protest in the US now, compared with that in 1968. And the Chinese government is very well practiced at controlling protest.

The Ideology of Occupation

January, 2019

In the last couple of weeks, two student groups were battling at Peking university, one of China’s most prestigious institutions. These were battles of words, not fists, but all the more intense for that.

Some might dismiss the conflict as a minor student skirmish over ideology. But the Chinese government reaction suggests that there is a lot more going on – that occupation by a ruling elite can have a light touch, except when it finds itself threatened. Existential threats, even small ones, must be put down.

To be sure, the conflict at Peking was not a contest for student body president, or a fight over which gendered pronoun to use in addressing a classmate. It was an ideological fight over who gets to interpret Marxism, and the fight illustrates the extent to which CCP, like every dynasty before it, can be understood as an occupying force. SupChina has the story- One Marxist student group is backed by the Party. The other’s WeChat account is blocked

Source: Socialist Worker – A Time of turmoil shaped Karl Marx’s ideas

One can understand this fight as that between “old” Marxists, who think the Party should be representing workers and farmers in class struggle, and “new” Marxists, who want the Party to continue its version of opening up and representing the major productive forces in the economy – like big businesses, the forces of capital, and – not coincidentally – the ruling elite. The old Marxists are thinking first of the workers at the university – dining hall workers, cleaners, landscapers – but also the farmers left behind in the rush to modernize and make money. The new Marxists represent the views of the university administration and CCP generally, and it is CCP that is in power in China.

At Peking, the new Marxists, representing the Youth League and supported by faculty and the university administration, seem to have won the battle. The social media of the old Marxists have been blocked, so they have no easy way of communicating with each other or with outside supporters, and individual students have been disappeared, expelled, beaten and arrested. The university administration and the government have seen to it that doctrinal interpretation will remain with the rulers in power.

American campuses have long had such labor-oriented protests and disagreements, though mostly pitting students against university administration over wages and benefits for non-academic employees. But the Peking conflict is one involving public speech, public writing, student organizing, and the fundamentals of Marxism. A ruling elite that is willing to give superior students – the future of the Party, the literati – some leeway in discussion was finally stirred to action. Finally, the hammer comes down.

Perry Link makes a similar point in The Anaconda in the Chandelier, which focuses on Chinese government censorship, but the analogy is the same. What might be scarier than a big snake in a chandelier? The snake hides above, unseen and unrecognized, lying quietly until stirred, and then it can strike without warning. Perry Link writes about elite preservation – … repression remains an important problem, and its extent and methods are still poorly understood in the West. To appreciate it one must re-visit a dull but fundamental fact: the highest priority of the top leadership of the Communist Party remains, as in the past, not economic development, or a just society, or China’s international standing, or any other goal for the nation as a whole, but its own grip on power.

Chinese claim more than two thousand years of continuous dynastic rule, and we wonder how that could possibly be achieved. Through dynastic changes and uprisings and invasions, why the return to the same system of governance – emperor and a small bureaucracy of literati overseeing a vast nation of farmers and traders. The ruling house and bureaucracy – the occupying elite – was relatively small, even into late Qing times. How could it be done?

There are several fascinating answers, but one that stands out is that the ruling elite generally kept a light touch on its occupation of the country. By occupation, I don’t mean a military force – this is not Japan in 1930s China, or Britain in India or the US in the Philippines. The elite needed sufficient taxes to pay for the imperial court and the bureaucracy, but beyond that, most governance and spending was local, with locally raised or extorted monies. A single magistrate might be responsible for an area with 100,000 or more people, and his staff consisted of clerks and runners paid out of his own pocket or with fees for services provided – a fee for bringing paperwork inside the building for the review by the magistrate.

A way of understanding this sort of occupation is Mancur Olson’s concept of the stationary bandit, described in his 1993 article Dictatorship, Democracy, and Development. A roving bandit sweeps in, steals what he can, and leaves. Such a bandit is a short term profit maximizer. A stationary bandit has incentives to steal less, so that he can remain to steal tomorrow. A stationary bandit with dynastic pretensions is only providing for his offspring and family if he steals enough, but not too much, so the family business can be preserved. In China, that model has worked on average for a couple of hundred years for each dynasty, before other conditions finally forced a change. When the new rulers came in, they saw the identical incentives. Chinese central government taxation was almost never excessive, nor were most central demands for corvee labor or restrictions on trade. The literati, the bureaucracy, or what we might now call the “deep state,” had incentives to remain in power as well, and the two combined to do so.

Economic historians Loren Brandt, Thomas Rawski, and Debin Ma argued in their article From Divergence to Convergence: Re-evaluating the History Behind China’s Economic Boom that the stationary bandit model works pretty well for Chinese dynasties. It is in that sense that we can see dynasties, and now CCP, as an occupying force. CCP must remain the only source of power, the only source of truth. Propaganda is marketing and defense for the Party, conducted in speeches, reports, news stories, editorials, electronic and social media. Representation of the peasants – the workers and farmers – is fine for political speeches, but let’s not get carried away. In other words, don’t start believing your own press releases. The CCP is an imperial elite in power, and intends to remain so. Students at Peking are the next generation literati. Remember?

Kent Deng at the London School of Economics argues for a historically stable triad among the three sets of actors – emperor, literati, and peasants. Any two of the three could align with each other to force change in the third – Development and its Deadlock in Imperial China, 221 BC-1840 AD.

In the Peking University case, we can see the ruling elite aligning with some of the literati – the best of the best in Chinese universities – against those who would advance the cause of the peasants just a bit too far. The old Marxists in this case want to talk about class struggle and working class allies. That is a step too far for the occupying forces. The rhetorical concept of the new Marxists, speaking to the old Marxists, is “The workers are living so peacefully, stop bothering them,” “Are you really being true friends to the workers? You’re just using the workers for your own purposes!”

The new Marxists understand the rule of power retention – “In order to study Marxism, the Chinese Communist Party must be embraced; opposing the Party means opposing Marxism.” In other words, you old Marxists, don’t look a gift horse in the mouth.

The old Marxists aren’t really opposing the Party, but they are rocking the boat. CCP has said many times that it will be the entity to determine what Chinese communism means. The student old Marxists just don’t get the Lord Acton proviso – ‘power corrupts, and absolute power corrupts absolutely.” It may be corrupt, but it remains in power.

Cultural Economy

In the old days, before about 1890, there was no field of economics. There was only political economy, rightly reflecting the link between institutions and laws and the incentives they created. As Acemoglu and Robinson pointed out in Why Nations Fail, what we call economics arises from the interplay of culture and institutions, and to think that economics is the same for all is to think poorly.

I want to point out some of the ways in which economic thinking can differ across cultures, and explain some of what we see in development in China, and in foreign countries with Chinese companies.

Economic issues are necessarily paramount for any national leader. Right now, both Mr. Xi and Mr. Trump derive their legitimacy from promises to achieve national greatness again, and for both, this fervent hope has much citizen – that is, cultural – support. For Trump, the political slogan is Make America Great Again; for Xi, Made in China 2025, or perhaps, Socialism with Chinese Characteristics for a New Era.

In China, this promise is more than a political slogan – more than, it’s the economy, stupid. For Xi and CCP, the promise of development is at the heart of the promise to the Chinese people. All other values are to serve that purpose. That has been CCP policy since inception. The CCP Constitution is pretty clear –

In leading the cause of socialism, the Communist Party of China must persist in taking economic development as the central task, making all other work subordinate to and serve this central task.

Chinese development internally has been one of the world’s great stories – from extreme deprivation and depression to dual tier markets and township village enterprises and some land rights and property rights and competition law and insurance and stock markets and financial markets of all kinds. The infrastructure miracle is the obvious sign of change for investors and foreigners alike. But China doesn’t seek to export its development model. It is understood that China is sui generis – except for infrastructure, where the universal model always seems to be, if you build it, they will come.

Many revenue-generating infrastructure projects within China seem structured as loss leaders for economic development, to the benefit of the local party chief. There just isn’t any way for the completed project to throw off enough cash to pay for all construction and development and operating costs. One sees this in some expressways, subways, some high speed train lines, some airports and ports. The completed projects are beautifully appointed white elephants. How can this go on, year after year, across China? Where is the ROI calculation? Where is the money coming from? Who is eating the losses?

One has to understand the difference in ways of understanding economics in China and the west. This means understanding how culture drives incentives. Economic interpretations are culturally implanted. Thinking about long and short term can be different. Thinking about goals can be different. What is rational can be different. Let me give you some examples. First, from the savings side of the market.

Example 1 – bank savings

It is about as fundamental an economic idea as there is. When returns go up, people invest more and restrain consumption. Interest rates go up, people will save more, and restrain consumption. At the national level, macroeconomists have to figure out the impact of potential changes in interest rates, exchange rates, employment rates and investment. What will people do? And while every situation has its own special character, when one has been making judgments for a while, one gets a feel. So it was with some surprise that I saw Chinese policy makers discussing the impact of a rise in interest rates on savings. This was at a time that policy makers were debating whether to allow rates on bank savings to rise, giving citizens a bit more of a return on their money, commensurate with growth in the economy, and ever-so-slightly slowing demand for money from developers and governments.

But what’s to discuss? If interest rates go up, people put more money in the bank. That is how the world works.

But maybe not always. Our standard assumption, seldom noted, is that people are unconstrained in their choice to save or consume – that is, people are free to alter their spending or savings pattern as they wish. For many savers in China – for most of us in the real world – that is not true. You know the deep cultural importance attached to education in China. Families, grandparents, will sacrifice mightily to save enough money to send their star student off to college, maybe high school, in America. That may take extreme savings over a fifteen year period, but the investment is considered worth it. If the grandparents have a defined monetary goal – $50,000 in fifteen years, then savings of $240 per month are required if interest rates on bank savings are 2%. Returns in the real economy might be 7%, or 10%, but savers never see those returns. But suppose policy makers allow interest rates to rise – say to 5%. Then monthly savings of $193 are required to meet the future monetary goal, and perhaps grandma and grandpa can eat a little better, or afford the medicine they sacrificed for the cause. Current consumption instead of savings. The policy question is then, will they spend the extra $47 per month, or save it? If you are a policymaker, how do you think about the goals of savings? If you raise interest rates, will people put more money in the bank – or less? Without some handle on the cultural features of savings, you don’t know. And don’t let libertarians or advisors whose understanding of economics includes no psychology or human behavior tell you that economics has no cultural biases.

Example 2 – trust and good faith

Getting to Yes is the well-known book on negotiating by Roger Fisher and William Ury. I think everyone in the world who has ever taken a negotiation course has read this book. In it, Fisher and Ury lay out the major principles for successful business negotiating over time – focus on interests, not positions; try to invent options for mutual gains; quantify or be clear about goals and measures of success. They are well aware that some negotiators lie, cheat, and distract, for the sake of the bargain. But a general assumption in the US at least, is that the parties are negotiating in good faith – meaning a sincere intention to deal fairly with others. In American contract law, good faith means that one party will not act so as to destroy the ability of the other side to receive intended benefits.

That is decidedly not a good assumption in negotiating in China. The best known classics of war, and negotiating, in China are san shi liu ji, 36 Stratagems, and sun zi bing fa, the Art of War, by Sunzi. Both are studied closely by students and businessmen. Both emphasize deception, misdirection, and secrecy in dealing with the enemy.

With apologies to Chinese businessmen who have been highly successful by acting in open and principled ways with Chinese and foreigners, good faith is not a good assumption. Stories about misunderstandings in completed negotiations or the irrelevance of a signed contract can be attributed to cultural differences. This is part of learning the turf. But other problems, such as quality fade, theft of molds and IP, even kidnapping of American business people over payment disputes, are not cultural, but simply describe dishonest behavior. This, when negotiations in China are designed to take extra time in order to build relationships.

Even within a company, growth plans can be secret, the province of only the owner. Survival and growth in the market is akin to warfare. Sunzi tells us that deception is a necessity, even when dealing with subordinates.

5:19 Energy – Thus one who is skillful at keeping the enemy on the move maintains deceitful appearances, according to which the enemy will act.

6:9 Weak Points and Strong O divine art of subtlety and secrecy! Through you we learn to be invisible, through you inaudible; and hence we can hold the enemy’s fate in our hands.

11:35,36 The Nine Situations It is the business of a general to be quiet and thus ensure secrecy; upright and just, and thus maintain order… He must be able to mystify his officers and men by false reports and appearances, Literally, “to deceive their eyes and ears”and thus keep them in total ignorance.

Per Sunzi, and per common practice, implementation in business or government can then be undertaken without clarity for underlings. It is a powerful tool in both business and government. Clarity for CCP underlings is not required when leaders are the only source of truth and know the goal. For leaders, lack of clarity permits use of oppression when unclear laws are violated. For citizens, lack of clarity requires self-censorship in word and deed. In business, proper use of unclarity and deception might induce the “other side” in any negotiation to reveal its secrets or preferences, or even act rashly when confronted with apparent delay or indecision. In the best of times, trust in good intentions is limited. There is no good faith in the absence of relationship built over time.

This is both a powerful tool and a crippling handicap in Chinese international infrastructure deals. Initial lightning speed and mystery in decision-making overwhelm opposition, but in the longer term, substantial good will is lost. We dealt with that problem in the US – the model of government action as “decide, announce, defend” became too costly in time and lawsuits. Better is “discuss, decide, build.” But that isn’t necessary in an authoritarian state.

Example 3 – infrastructure investment

We are all astounded by the sheer extent of Chinese infrastructure investment in the last ten years. The stimulus in 2008 was far larger, as a per cent of the economy, than the American one. But those of us with some boots on the ground are also astounded at the sheer wastefulness of some of that investment. We know that these projects are financed by bank loans, and those loans come due in three years or so – banks are not long term lenders. And aside from projects taking three years to build, we have the experience of (theoretical) revenue generating projects that cannot possibly generate enough money to pay for construction and interest and operations. No way. A favorite example of mine is a new expressway built from Shanghai to Pudong, where the international airport is located, completed about 2008. My first trip to the airport in 2008 was uneventful, for the simple reason that there were hardly any other vehicles on the road for 30 miles. I mean, nearly zero. At the time, this was a new expressway, and I suppose the information of its availability could have been scarce. Possibly. But I used that expressway at least twice a year for eight years, and the level of congestion hardly changed, anytime of the day or night, weekend or not. Nearly no traffic.

There were simply too many other competing routes to the airport. Big mistakes are possible everywhere in the world on infrastructure projects, the US being no exception, but we see similar stories repeated across China. Transportation economists and engineers work pretty hard to forecast traffic and revenues, consider alternative routes and toll costs, and while the results are less than perfectly accurate, they are a decent guide to the investment decision. But voters in the US, not to mention bond holders, would be more than a little exercised if their investment produced no ability to repay after so much planning. Is there a different calculus in China?

Chinese planners have the means to make perfectly rational decisions about such matters. So how can such revenue-short projects get built over and over again – aside from the pressure on local officials whose promotions depend upon generation of a target level of GDP in their three or five year term, and the need to spend following the huge 2008 stimulus. Is the investment planning really for a twenty year horizon, at which time future demand will be sufficient to pay off the loans? (I did transportation planning and economics work for some years. There is no twenty-year projection of expressway use that is worth the spending of electrons to produce).

There is a way to make sense of these deadbeat projects, whether they are expressways, high speed train lines, airports or commercial ports. And there is a way to understand the difference with western decision-making. Given that the real decision is a political one, even more so than in the US, the trick is to consider than the long term doesn’t really matter. A little bit of the cynical Wall Street IBG, YBG – by the time it matters, I’ll be gone, you’ll be gone.

How to understand this? A simple chart from econ 101 should help. A key point to understand is that the construction contractors, lenders, and local government investors in these projects are either government entities or heavily government-compromised. While many big SOE make big profits, the companies can have political goals as well. This means that they are not strict profit maximizers, in basic econ terms. This also means that someone will take care of them in times of trouble.

Many, if not most, expressway projects in China are constructed by SOE as what we call B-O-T projects – build, operate, and transfer. The concept is that the SOE contractor borrows the money to build the expressway, and receives tolls for a period of time – twenty years, let us say – to repay the loan and provide profits for the contractor. At some point in the future, the right to receive tolls reverts to the original government owner of the expressway.

But what happens when tolls are nowhere near enough to pay back loans? This is a rather common problem. Or would be a problem in the US. Two particular ideas of “capitalism with Chinese characteristics” pertain here.

Loans for construction are bank loans, but the borrower may include local governments where the branch of the lending bank is located and even though loans come due every three years or so, the loans can be rolled over again … and again. That is part of what the SASAC (State Asset Supervision and Administration Commission) does – help borrowers roll loans among different local lenders. At some point in the future, someone will have to deal with these problem loans – perhaps one of the “bad banks” created for that purpose. But that is not now. Just FYI, my favorite expressway to Pudong is now being handled by the one of the SASAC units in Zhejiang.
But wouldn’t the construction companies get cold feet, or nervous about not receiving planned income or having to repay the banks? Not necessarily. In many recent cases, the borrower is actually a partnership between local governments and an SOE contractor. And here is a neat trick, that could – theoretically – explain how the contractor can sleep at night.

How do regular retail stores decide to close for the evening, or the season? How does a Starbucks decide to close at 10:00 PM, and then, miraculously, reopen at 6:00 AM? Why not stay open all night? Or, the ski lodge – open for five months a year, then close for seven months, and reopen? How can this work, with mortgages and taxes and rents to pay?

The econ 101 answer is that businesses will shut down temporarily when revenues cannot cover average variable costs – for Starbucks, the cost of salaries and cups and coffee and heat or a/c. If these variable costs can be covered, then the store will remain open. If not, then close down and reopen when there will be enough customers – in the morning – that you can reliably cover average total costs. In the morning, you will begin taking in enough revenue to cover operating costs and the bank loans and interest and rent and insurance and other fixed costs and make a profit. In the short run, you stay open if you can cover average variable cost. In the long run, you have to cover all the other costs as well, but that is the long run. This is also the situation for the Chinese expressway with little traffic.

Stay with me on this, and the graphic representation will help.

In the figure below, you can see that the price P of the good is still above average variable cost AVC at the quantity Q being sold. In this case, the seller should remain open, as long as the seller is confident that sales will pick up at some point in the near future (the morning) and sales quantities will then be at or above average total cost ATC. Think of the price here as the price of the average sale at 2:00 AM; by 11:00 AM, both the average sale and the quantity sold will be greater, putting the company into a profitable situation again.

Even though the firm is not earning any economic profit, it is earning enough to pay their laborers (AVC), and thus it incurs less loss compared to the whole of average fixed cost.
In this situation, the company should continue producing the product.
P = MR > AVC , P = MR < ATC –> point where MC = MR minimize its loss
Economic loss = Q (ATC – P)
When AVC < P < ATC, the firm can stay open as long as they can cover the AVC
If a firm can cover all of the AVC and even part of the fixed costs, they will lose less than shutting down, as MR < ATC
- Shutting down would mean losing everything and still have to pay for fixed costs, while in the loss minimizing case, costs are still covered.

Source: Welker’s Wikinomics

The same concept can apply to Chinese construction companies in BOT projects. Loan servicing costs don’t really matter. Someone, sometime, will deal with that, in the long run. If tolls from cars and trucks – and tolls are very high in China^* – can cover operating costs – labor to collect tolls and trim bushes – then the project can remain open.

^*Example – passenger car tolls for the 600 mile trip from Hangzhou to Jingzhou, in Hubei Province, are about 500 yuan, one way – say $75.

This is only a theoretical example. I don’t really know if this is the thinking behind expressway projects that will never make money with debt taken into account. More likely is the the leader at some point said, proceed, and at that point, money became no obstacle. And obviously some projects can pay their debts. You can see why big projects are often development projects, with revenues from related operations – retail stores, sales of apartments, rental from offices – rather than simply infrastructure projects. Just like the building of the transcontinental railroad in the US, where the railroads were given land to use for non-railroad revenue.

The example shows what could be a rationale for continuing to operate the expressway. And a positive spin on this story would be that to a much greater extent than in the US, Chinese infrastructure projects are expected to pay for themselves.

When they cannot pay for themselves, loans are, in fact, rolled over again and again. At some point, these projects with negative economic value must be recognized as such, and GDP will suffer as the project is written down to some value via sale to a third party, all the partners and the bank will need to take a big hit, or else someone – some government – will need to continually feed money into the project to cover debts. This process usually happens quickly in the US, in bankruptcy. In China, the process can take many years, but that is what the “bad banks” are for – to take the otherwise uneconomic projects and run them until they can be sold to someone or debt finally paid off by the Ministry of Finance. The current idea is to convert the bank debt into bonds owned by the banks, and let the banks sell the bonds to (haha!) foreign investors. Win-win!

Example 4 – stock investing

Stock markets were originally intended to accomplish two tasks – provide a source of funds for SOE, and “privatize” some of the risk. These efforts succeeded, and now most companies on the Shanghai stock exchange are SOE, with private funds supplementing a major government position, either ownership or management. Two way foreign and domestic stock market trade between Shanghai and Hong Kong has been allowed since 2014, and there is now an rmb clearing function in London, meaning trades can be settled in rmb outside of China. Now the government is pushing quite hard to get foreign investors directly into stocks and bonds in China.

My own somewhat cynical view is that this is not in the long term interest of Hong Kong or London – or foreign investors. As long as CCP controls markets in China – and Mr. Xi is reestablishing the “Party is fundamental in all markets” philosophy – markets will not receive the sort of information needed to function efficiently. Observe how much markets in China are affected by news reports or a speech by a particular high level official. And observe the somewhat herd-like behavior of Chinese in purchases – a good word from the government suggests safety and profitability in a nation critically short of widespread basic economic news, not to mention divergent views.

Michael Pettis does a superb job in pointing out the structure and pitfalls of China investing. He is one of the few China macroeconomic analysts with both western and Chinese investment trading experience, as well as the academic chops to put all in context. Those interested in China financial markets should not miss a posting, now hosted at the Carnegie Center for International Peace. Every post is rich.

Pettis writes most about overinvestment and the necessary macro adjustments, but his writing about the stock markets is also insightful. Writing in late 2013, he made an important point – The recent Nobel Prizes in economics suggest both that markets are efficient, and that they are not. In fact they are likely to be efficient under certain conditions and inefficient under others.

Pettis argues that stock markets can be efficient at allocating capital under some conditions and not others. He sees the need for an appropriate mix of three different kinds of investors, with different investment profiles, which he terms fundamental investors, relative value investors, and speculators.

It is now 2019. I don’t follow the Chinese stock market, and perhaps Pettis now has a different view. But the fundamental conditions seem unchanged to me, if not more destabilizing than they were in 2015 and before.

He defines the three segments as follows –

Fundamental investment, also called value investment, involves buying assets in order to earn the economic value generated over the life of the investment. When investors attempt to project and assess the long-term cash flows generated by an asset, to discount those cash flows at some rate that acknowledges the riskiness of those projections, and to determine what an appropriate price is, they are acting as fundamental investors.

These investors are buying the long term trend of the economy, or the long term prospects for an individual company. They want good financial information on companies.

Relative value investing, which includes arbitrage, involves exploiting pricing inefficiencies to make low-risk profits. Relative value investors may not have a clear idea of the fundamental value of an asset, but this doesn’t matter to them. They hope to compare assets and determine whether one asset is over- or underpriced relative to another, and if so, to profit from an eventual convergence in prices.

These investors are buying the shorter term trend in the market, and perhaps choosing among individuals stocks in one industry, based on what information they have.

Speculation is actually a group of related investment strategies that take advantage of information that will have an immediate effect on prices by causing short-term changes in supply or demand factors that may affect an asset’s price in the hours, days, or weeks to come. These changes may be only temporarily and may eventually reverse themselves, but by trading quickly, speculators can profit from short-term expected price changes.

These investors are looking at price changes over a span of minutes, hours, or days. They respond to signals that are clearly not fundamental to the growth of the economy, such as insider behavior or political announcements.

Michael Pettis. The Difficult Politics of Economic Adjustment. China Financial Markets, November 11, 2013. Now at Carnegie Endowment for International Peace as When Are Markets Rational? Note – versions of this newsletter are available online, but for the most part they do not include this stock market analysis. The stock market portion of the post is at Naked Capitalism.

Pettis argues that stock markets in China are inefficient because the data necessary for fundamental investors – good macroeconomic data, honest financial statements, clear corporate governance – is lacking; and China has few value investors, because the conditions they need – ability to trade frequently and quickly at low cost, and ability to short securities – is also absent. Speculators, he says, trade against very short term trend information, and are unconcerned about long term market fundamentals for a particular company. China stock markets are dominated by speculators.

One could categorize these three investor types as having long, medium, and short term horizons. Each type of investor looks at different information or analyzes the same information differently, and an efficient market can result when all information is available on which to trade. Without a good mix of all three, markets lose flexibility, and don’t allocate capital well. The Chinese markets are necessarily dominated by speculators – roughly 80% of stocks are held by retail traders, mostly individuals. The top ten listed companies on the Shanghai exchange are SOE, and most of the companies and the values are in government owned companies. China has pension funds and insurance companies that can take a long term view; but even those industries cannot get access to trustworthy and general fundamental information on companies. As a result, markets can be very volatile.

Example from Financial Times, September 27, 2017 –

When China’s vice-minister of industry said this month that Beijing was considering setting a deadline to ban sales of fossil fuel-powered cars, most auto industry experts did not overreact. The official did not offer any timetable, and rich countries such as Britain and France have set distant deadlines of 2040. Judging by the market reaction in Hong Kong, however, investors could be forgiven for thinking the statement was a bombshell. Shares in BYD, China’s largest producer of electric vehicles, surged to a record that day and are up more than 60 per cent this month. After BYD’s chairman speculated China’s deadline could be 2030 — in what experts said was more of a lobbying effort than a prediction — shares in the group’s separately listed mobile-handset unit also hit a record, despite the fact the company is not even involved in cars.

Not even involved in cars.

Even today, 80% of the listed companies on exchanges are SOE. There can be little investor confidence in any market data, from government or an individual company. Pettis notes that even credit decisions must become speculative, because when bankruptcy is a political decision and not an economic outcome, lending decisions are driven not by considerations of economic value but by political calculations. See the example of Pudong expressway construction above.

There are plenty of other ways in which “economics with Chinese characteristics” is different from that in the US – some of those ways make much more sense than what we think of as normal economics. I thought it would be fun to point out some differences – for good or for ill – that could lead to cultural, institutional, and even economic change in the US. After all, we import just about everything else from China. Ideas may be next – after all, Mr. Trump and the GOP follow Mr. Xi and CCP in political philosophy in so many ways now. Lightning speed and mystery and decision-making for the oligarchs and financial instability – no infrastructure, so far, though.

Are you getting hammered from the typhoon?

The constant question from the US in fall of 2015 …

Hangzhou, Xihu District, Shui Mu Qing Hua residential development. Reporting from the front. On the fifth floor.

Liu hé lu, the street right outside the school and our apartment complex, was flooded today. That is the only exit from our development. Late in the day, there was occasional traffic in each direction in the west bound lanes only; a few of the brave drivers who made the attempt did not stall or get flooded out. Other major local streets were also flooded, and closed. There is no other way in or out of our development, and all the other developments to the west of us. The thousands of us were stranded, at least for the rest of the day. The street floods a couple of time a year anyway, so this was not unexpected.

Source: Englishsina.com

Source: chinadaily.com.cn

We have no school tomorrow morning, since the school felt that many teachers, who live just a few minutes away but have to travel liu he lu to get here, will not be able to make it. Maybe have school in the afternoon. Contact everyone by wechat, and teachers should stand by, ready to respond.

Literally closer to home, we had some ceiling leaks coming from the apartment above. We are on the fifth floor of a six-story walk-up.

So, lessons about real estate in China – the apartment above is owned by a woman from Guangdong, in the south of China. Currently, no one lives in the apartment above. The owner will not decorate it – do the buildout – because it is not worth it to get the rent. One reason why apartment construction is so much faster in China than in the US is that the work done by the developer is so much less – excavation, foundations, concrete block walls, plumbing risers with stubs into units, same for electricity, poured concrete floors, stairs, windows, exterior doors to apartments, c’est fini. At a point when an American developer would be about 50% complete with the project, the Chinese developer is walking away. The apartment above us is left in its pristine original unfinished condition.

The owner above us rents the apartment out as is, bare concrete walls, sort of a makeshift squat toilet and tiny sink. No kitchen at all. No furniture, of course. No lights, no gas.

She rents this apartment to students, and to construction workers (farmers) working on local projects. The rent is clearly unstable, and the apartment has been vacant for a few months now. When students were living there, the owner had divided the apartment with makeshift walls and doors into five or six separate units, each about 10 square meters, that student couples rented. Sort of “starter” apartments for couples. The students or workers run some bare wires, attach some light bulbs. Take some plastic tubing, lay it on the floor, and that is water supply to a sort of kitchen and a bathroom. Tape some plastic pipe to the concrete wall to get a shower effect in the bathroom. You get the idea. Not quite up to code. But no problem in libertarian China.

With no one living there, the owner gave the key to the management company for our development that hires people to take care of landscaping, general cleaning, trash removal, and the guards.

It appears that people from the management company, or their contract workers, would use the apartment from time to time. In any case, it appears that some of the windows above us were left open during the typhoon, hence the inch or two of water on the floor, hence our ceiling leaks. Since the apartment above ours is the top floor, it is also distinctly possible that the leaks are coming from the roof, probably not the flat parts but from flashings or places where pipes go through the roof, maybe with little or inappropriate flashing. There are also a couple of windows out in the unit upstairs, certainly a big source of water in a typhoon.

Whatever the source, the problems became evident yesterday morning, when the dining room ceiling began to leak. Qing called the management company – three times – before someone came over to take a look. First call – call answered, promise to send someone over, but no physical response; second call, not our problem, call the owner; third call, this time a bit more insistent, then five people show up, with little dust-cleaning pans and brooms that one might use to sweep the kitchen floor. Very light duty if all one were doing is mopping the floor as part of a daily routine. This was ceiling leaks in five or six places in our apartment. Chinese response -lots of labor, few or poor tools.

But sometimes throwing labor at a problem works. In about an hour, they had the floor about as dry as it was going to get. The leaks have stopped in our apartment. We asked the management company to keep the door to the unit open, so we could inspect over the next couple of days. They agreed.

Joking, I told Qing to call her insurance company. There is no property insurance. The owner of the apartment above does not have insurance either. In these cases, as with the car accidents, the parties are supposed to meet and try to come to some settlement, on their own, without lawyers or police. There is no concept whatsoever of government building or housing inspectors.

The bureaucratic response of the management company to Qing’s phone calls is familiar. Qing finally resorted to the “I pay you, you should do something” approach, and that seemed to work. In China, many of the people who own apartments do so at no out-of-pocket cost, other than the mortgage – there is no property tax, they carry no insurance, and they refuse to pay the small monthly management and maintenance fees. There are apparently some abilities to get owners to pay the maintenance fees, but the measures are not used much, as I understand it. Just too hard to go after people. So property management companies tend to be underfunded – not only a Chinese complaint – without recourse. Garbage gets picked up, guards function as guards, some cleaning is done – but anything else, apartment owners are at the mercy of whether their fellow owners have paid their dues, in addition to the usual bureaucratic delay. It should go without saying that the budgetary processes are opaque. It is not at all clear how to find out whether the property management company is getting money and not spending it, or just not collecting, or just using it elsewhere.

The owner of the apartment above will send over a friend, today, to have a look and discuss some settlement. The friend, and Qing, will use their extensive construction expertise to decide on the costs of fixing our ceiling and remuneration for any problems that might show up next week.

So, lessons –

owners have no responsibility to take care of property. Nor do management companies. All is caveat emptor.
management companies do not maintain “common areas” beyond some light cleaning. If the roof leaks, the owner below the roof should fix it. This is one reason that the top couple of floors in a building tend to be priced less than units a few floors down – more risk for maintenance costs.
“local knowledge” can be effective at solving problems – lots of labor and no proper tools does work, sometimes
bureaucratic response is bureaucratic response, no matter what country
owning apartments is easy if there are no – zero – costs of operation
but zero costs of operation means that the common elements, even the landscaping and the guards, are at the mercy of how many people decide they will make the (ridiculously small) monthly dues payments
so China suffers from standard tragedy of the commons problems – it is in no one’s personal interest to make dues payments, hence the property as a whole suffers
in libertarian China, problems should be resolved by discussion and negotiation between the parties. How charming! How civilized. How ignorant of the details of problems, and their resolution, and particularly, how ignorant of the role of power in personal negotiations. It is not clear to me that more lawyers and legal processes always make the world fairer, or better. But no lawyers and no rules certainly constitute a libertarian heaven.
it is important to see these elements – construction, management, repairs, evaluation of performance – operating as a system. As a result, poor performance in construction, or anything, is excused – a solution can always be negotiated later, when the problem occurs. This reminds me of the “fatalism” thought to be part of eastern culture. There is little thought to the consequences of actions, or impact on others. What happens, happens. Who could have predicted? In the US, friends of mine had a fire in a townhouse they own, the result of poor wiring. They are considering the liability of the original contractor who built all of the units, in their fire discussions. There is no such concept here.

In the system, you see the importance of face – landscaping is well maintained, the guards have uniforms. But real maintenance – painting of railings on fences or balconies, roof repairs, repair of broken sidewalks, securing window openings with no glass – those things are never considered.
there is the ultimate tragedy of the commons problem – it is assumed (as we do in economics, generally) that everyone is doing the best they can, most or all of the time. It is assumed that people do not intentionally do less than that of which they are capable. But the bar for “the best that one can” is very low here. As a result, everyone goofs off. There is no inspection, evaluation, auditing, testing, checking up – that is worth the time spent doing it. There is a lot of reporting, and checking, and looking over somebody’s shoulder – but the results of that are often left in the pile of monthly reports, and never make it to real action in the world. I have some knowledge of this beyond experience with our own apartment. Qing’s brother-in-law, who lives with us, is a construction inspector. So is his son, and I have interviewed both at some length. To confront someone with not having done as good a job as is possible is a loss of face. I am making a bit much of this – there is plenty of yelling and screaming at each other over quality – but that seems to be discussion about work in process. Discussion of what has already occurred is considered too difficult – requires expertise and power, and often best just to preserve the relationship and accept the consequences. So, anything in which quality is difficult to assess at the point of purchase – construction, teaching, cars, food – is suspect.

Anyway, this is what I was thinking about while I watched women use dust pans to scoop up water that was otherwise going to be coming through our ceiling in a few minutes, if they did not move quickly.

So which is the more civilized – that the government regulations force behavior, with ability to sue and be sued, or that people should talk with each other, and discuss, and come to some agreement about a solution? Are people born good, or not? Do people learn goodness, or evil? Does regulation remove moral responsibility? We talk about this all the time in the US.

The key issue is power – tenants cannot turn on the heat in a central heating plant, and they don’t know a good roof from a bad one, a dangerous situation from a benign one. When functioning well, the government serves to equalize power relations, which includes technical expertise.

And you see the enormity of the Chinese development model problem – I mean, with so many people, you expect capital to garner a large share of profits. Scarce capital is worth more, relatively. But even now, how can so many people be kept so poor, even in the face of opportunities to make money and improve – fix buildings, test for quality, provide evaluation services? The answer lies in both culture and organizations. Chinese organizations work for the benefit of capital – it is illegal for a group of us to put money together and build a building, even in the face of enormous demand. It is illegal for us to organize to get better treatment. It is difficult, if not impossible, to sue over poor conditions.

And Chinese do not want to trust a small company over a big one. A big company has power, stemming from obvious relations with the government. A small company has no relationships. So the culture biases in favor of the big over the small.

And one more note on our leak problem – four inches of concrete serves as a decent water barrier, in these conditions. Socialist concrete construction works better in poor water conditions than American capitalist three inches of concrete on steel joists. That is one reason why roof coverings are so poor in China – no one feels they need to maintain roofs, because the concrete does an ok job, except at joints, and any leaks are either the responsibility of the person suffering the problem, or are in common areas, which no one cares about.

And yes, on the scrutiny of consumer products – I have seen many people do that here, students from IIT and Qing and others. They are looking for an indication of quality, expiration dates, some hint that the product they are buying might be ok to use. I saw this among IIT students, and Qing, in stores in China. In the grocery store in the US, I grab a bottle of milk or bread from the shelf, and pay and walk out. Chinese pursue the fine print. Government regulation and culture.

Update on threats to Anne-Marie Brady

… and an update 12-11-18 on the update. A senior US official offers intelligence agency cooperation on Chinese interference in New Zealand, citing in particular the Anne-Marie Brady incidents. And a closed circuit camera is now in her office, which was broken into after publication of her research on CCP influence in New Zealand. No word about protection for her home, her car, or her person.

Back in September, I wrote about threats and break-ins directed at Anne-Marie Brady, a New Zealand scholar who has written about CCP influence in foreign affairs. Her recent work is titled Magic Weapons – China’s political influence activities under Xi Jinping, an investigation of United Front activities such as media and university partnerships, “management” of overseas Chinese, and multimedia communications strategies to influence and co-opt foreign citizens and Chinese outside China.

Brady’s office has been broken into twice, her home once, and her car burglarized. Chinese media has attacked her, and there is no rationale for these attacks other than by persons hired by the Chinese government to intimidate. The September piece is Intimidation Knows No Boundaries. Brady has asked for protection for her person and property, and the New Zealand government has done nothing, with approval from Chinese media.

Now an open letter to the New Zealand government has been prepared, requesting protection for Brady and support for open inquiry. Brady is by no means the only scholar to face harassment or intimidation outside China, for their work on China. From SupChina, Thursday, December 6 –

In October, Index on Censorship reported that “anonymous, threatening letters” were sent to residential addresses in the U.K., apparently with the aim of stopping “activities that the Chinese government disapproves of.” Recipients included family members of Tom Grundy, editor of Hong Kong Free Press.

The open letter is here. Quoting –

These circumstances make it likely that this harassment campaign constitutes a response to her research on the CCP’s influence and an attempt to intimidate her into silence.

Radio New Zealand has reported on the issue, and the letter.

I have signed the letter. Most everyone on the signature list is a better known journalist or scholar than I, but no one seems to have listed an affiliation inside China. We will see what happens.

What’s New is Old Again

on tangibles and intangibles in the trade conflict

Fake LV bag

Source: Wondermika
(note – access to Chinese Constitution at this site is now forbidden)

From Caixin –

China Starts New Crackdown on Intellectual Property Theft After Xi-Trump Talks

Thirty-eight state agencies have announced that they will soon begin a coordinated campaign against IPR infringement

From Bloomberg, via Slashdot –

China has announced an array of punishments that could restrict companies’ access to borrowing and state-funding support over intellectual-property theft. … Bloomberg reports: China set out a total of 38 different punishments to be applied to IP violations, starting this month. The document, dated Nov. 21, was released Tuesday by the National Development and Reform Commission and signed by various government bodies, including the central bank and supreme court…. violators would be banned from issuing bonds or other financing tools, and participating in government procurement… also restricted from accessing government financial support, foreign trade, registering companies, auctioning land or trading properties. In addition, violators will be recorded on a list, and financial institutions will refer to that when lending or granting access to foreign exchange. Names will be posted on a government website. “This is an unprecedented regulation on IP violation in terms of the scope of the ministries and severity of the punishment,” said Xu Xinming, a researcher at the Center for Intellectual Property Studies at China University of Political Science and Law.

Admirable. Thirty-eight agencies, thirty-eight punishments, and a coordinated effort within hours of the Xi-Trump non-agreement (the crackdown actually publicized in China before the Xi-Trump meeting). When announcements of this extent come so rapidly, one may be pretty sure that nothing of consequence will happen. IP theft is the only real issue in the trade war. All else – deception or fraud in business dealings or failure to abide by (American) labor or environmental standards, are par for the course in international trade. Not that they should not be addressed, but there are other ways – better negotiation on the part of American businesses with Chinese, or efforts by international NGO and multiple foreign governments on labor and the environment. Trade wars do nothing to address those issues.

A Chinese program to address IP theft should encompass theft both in China and in the US. The recent coordinated announcement has no value. And there are multiple ways in which it has no value.

First, feigned compliance with rules from above is a standard operating procedure in Chinese governance, and has been for centuries. A leader proposes, the officialdom disposes. Officials responsible for implementation of any rules are responsible to their local Party leaders, not to Xi or to some sense of obligation to openness and fair dealing.

Second, provincial or local-level officials who do seek to vigorously comply with an actual rule put themselves at a disadvantage for promotion. Increasing GDP is still a measure by which officials are rated for promotion, and hindering local business growth for the sake of discouraging IP theft from the foreign barbarians is hardly a good idea. Businesses of any size, particularly the very large non-SOE businesses, are now required to have a CCP committee. That Party leader will have a relatively high status within CCP. No one can know the internal machinations of the discipline inspection bureau or the organization department, but it is by no means clear that a Party leader at a large business would cooperate with a national plan rather than a local colleague with local interests at heart.

Third, remedies available within China are insufficient to address IP theft. We should distinguish two broad kinds of theft – theft of tangible and intangible products or designs.

On tangibles, the government has made efforts in the past few years to cut down on fakes sold on the street, on Alibaba, and in foreign countries. There has been some success, but fakes are still easy to purchase everywhere in the world. An equally damaging kind of tangible IP theft is the illegal production of goods beyond amounts contracted by the purchaser, which are then sold in China or elsewhere in the world, Africa or the –stans. (Prices to the original western buyer can be held very low if additional copies can be sold elsewhere in the world for a lot more money. Contract to produce 100,000, make 200,000, sell the overage privately). See from 2011 – China to crack down on fake iPhones and from 2015 – China to crack down on selling fake goods online One should not doubt that we will see comparable articles in 2019 and beyond. And theft need not be actually undertaken by a contracted supplier. A cousin or closely related startup business would be sufficient.

The thirty-eight agency announcement, signed by the central bank and the supreme court, is still not a credible promise of crackdown on theft. In the absence of rule of law, with local courts controlled by CCP and subject to undue local business influence, local control will still dominate transactions. In any case, there are penalties and there are remedies. The list of penalties in the article above sounds impressive – serious restrictions on obtaining loans or travel. As always, the proof of this pudding will be in enforcement of agreed intentions. I suggest that most penalties will continue to be confined to some payment of money for theft of sales, or return of molds. Months or years later, while a case winds its way through the Chinese courts, some minor compensation for lost sales is small recompense. Monetary remedies continue to be limited to some estimate of actual sales losses – no deterrent damage amount is assessed. Theft by fake registration of copyright in China, or aggressive adverse copyright, will remain a problem. Michael Jordan was able to win his trademark dispute after a years-long battle over use of the Chinese characters for his name by an unrelated shoe manufacturer. Jordan had the money and the time.

Steve Dickinson at China Law Blog, comments on the G-20 “agreement” – As someone who has been involved with these sorts of China IP issues for decades, I view the odds at near zero that China will make significant and meaningful changes in their system on the issues that will be discussed.

With regard to intangibles, there is no advantage to China in restricting or punishing theft – military or scientific or commercial designs, or molecular design or software. If Trump were to get China to agree to restrict or do away with “China 2025” – itself a ridiculous request – China could drop the marketing and continue with the practices.

Theft of intangibles is the key issue. More than one Chinese researcher has been arrested in the US for theft of IP with intent to sell to a Chinese company. See here, here, here. Of local interest, one of those arrested was a student at IIT in Chicago.

Fourth, what punishment compensates for theft of intangibles? Will Chinese scientists or company owners agree to return the designs or software? That will work. Siemens and ThyssenKrupp never even bothered to sue for theft of high speed train designs. See Der Spiegel from 2006.

Non-tangible theft can be kept secret for a time, and in any case, a lawsuit will need to wind its way through Chinese courts, where western concepts of discovery and evidence are … well, foreign. And lawsuits don’t work if politics intervenes, on either side. Trump’s hard crackdown on ZTE for violation of Iran sanctions was substantially softened with a phone call from Mr. Xi.

None of this addresses other “Its China” problems, such as unequal enforcement of regulations or complete disinterest in pursuing a request from foreign business for licenses (See China Law Blog on driving out Mister Softee). Other tactics include local favoritism in selecting contractors or refusing to pay for services rendered. Several years ago, I tried rather hard to line up an American architect to work on urban planning projects for which the contract in China was already in hand. I could generate no interest. American architects had learned the lesson of supplying work and then going unpaid.

Posted in Legal News, cited at China Law Blog –

If, like us, you’ve been following the China Law Blog for many years, you can’t have missed the numerous warnings it gives about the futility of obtaining judgments against Chinese companies in foreign courts since Chinese courts will not enforce them unless they were granted by a court in one of the limited number of countries with which China has a bilateral enforcement treaty. Furthermore, even where a treaty does exist, as is the case with Hong Kong, it can be extremely difficult if not outright impossible to get a foreign judgment enforced in China.

This is from 2015, and Xi is proposing changes in the law. But changes in law say nothing about changes in interpretation of the laws in court or later enforcement. It is still, “good luck with that.” You should take it as dispositive that Mr. Xi has said nothing about changing the way courts are operated or controlled. And our own dear leader never asked.

China Reflections

Tag: Moderately well acquainted reader