Interview by Keith W. Rabin
Hello Jack, good to see you again. Before we begin, can you tell us a bit about your background and current activities?
After graduating from Yale and the Harvard Business School, I joined Paine Webber, where I served for 20 years and ended up running the Investment Banking Department. After doing this, I decided that I wanted to do something different and looked for a long term trend that I could somehow get in front of. That led to my first trip to Asia in the fall of 1990. I followed that with a series of trips in 1991 and then moved to Hong Kong at the end of that year. I quickly decided that China was the place to focus, and in 1992, I made my first trip to the Mainland. This led to the establishment of ASIMCO Technologies, an automotive components company, in 1994 to supply the emerging Chinese auto market. Over the next 15 years, I built ASIMCO into a company with 12,000 employees, 17 factories and about half a billion dollars in sales.
There are two things about what we did at ASIMCO that make me especially proud. First, we localized management and were twice named as one of the 10 best employers in China in surveys by the Wall Street Journal and Hewitt Associates. The other thing we did was to learn how to sell to Chinese companies in the local market. In recognition of what I had done, I was named by China Auto News in 2008 as one of the 30 outstanding entrepreneurs in China’s auto industry over the 30 years of Chinese economic reform. I was the only foreigner on list.
That demonstrates that we were able to create a Chinese company, and to me, that is the key to success in this market. I left ASIMCO in 2009 and founded JFP Holdings to help companies enter the Chinese market and to help Chinese companies to expand abroad.
China has delivered several decades of double-digit growth and recently surpassed Japan to become the world’s second largest economy. Can China sustain this performance? How is it possible to sustain this high level of growth year after year? Are their policymakers that good? How reliable is the data in any case?
When China began to reform, 70% or so of its employment was in the agricultural sector. After 30 years of development, it is now down to about 50%, but there is still a long way to go. When you take someone off the farm and put them into a factory backed by capital, the productivity increases are enormous. Therefore, the transition from an agricultural to an industrial economy, particularly on the scale we are seeing in China, leads to enormous productivity gains. Growth in the past has been driven by investment from other countries and China has typically been the largest magnet for FDI. The government has also been an enormous investor into infrastructure and these projects then pave the way for future increases in productivity. Going forward, the shift will be for China to develop as a consuming nation.
Is this sustainable? Yes. There is a great deal of momentum behind this trend. That doesn’t mean, however, that there will not be bumps in the road. Generally, with some reservations, you can trust the numbers coming out of China, and in many cases, there is corroborating evidence to support them. In automobiles, for example, 70% of the passenger cars produced in China are made by foreign-invested companies. So, if a 50% increase is reported, you can verify the number based on the numbers supplied by the foreign car makers. In any case, the data has become more reliable over the years.
What about potential banking problems or efforts to cool off real estate speculation? Are the stories we hear of uninhabited cities built simply to realize local growth targets and to maintain employment true?
I don’t see too much of that, and to extent you do see it, vacant properties tend to fill very fast. Pudong was established as a special economic zone in 1994, and in 1996, I was there and was curious to see for myself. It looked like what you describe here -- an empty city that looked as though it had been hit with a neutron bomb. The place was filled with many big, empty buildings, but no people. I scratched my head wondering, but in six months it was filled. I think there is bit of exaggeration about the empty cities, and most people don’t realize how quickly capacity gets utilized in China, given how fast the country is growing. The property market has been red hot. Some would say it is overheated, but the government has tried to slow it down. They’ve reacted quickly by limiting mortgages and initiating other cooling measures. Are there a lot of bad loans? Yes, but I don’t think it’s to the point where it will lead to a banking crisis. In fact the banks are recapitalizing. The Agriculture Bank of China just did a successful US$22billion IPO, and I see there is another 70 billion in bank financings coming along to deliver fresh equity into China’s financial institutions.
When discussing China it is a mistake to speak about it in a uniform voice. Can you talk about the differences between the North and South? The Coast and Inland regions? We also hear conflicting reports about how much control the central government maintains on local developments. Can you comment?
China has had tremendous growth, but it has been uneven. The biggest growth has been along the coast and in major cities such as Guangdong, Shanghai and Beijing. They have had the fastest growth, and there has been growth inland, but it has not been as dramatic. Between North and South, people will say the South is more business-oriented and easier, and those generalizations are useful, though not 100% reliable. There are differences in the cost structures between different areas which can be very dramatic. Companies like Foxconn, which makes ipads, are moving their factories from the south into the inner provinces. For me, the most useful way to look at China is through its income structure. Of the 1.3 billion living in China, about 400 million have an average income of US$8,000 and about 900 million have an average income of US$800. That is a wide contrast and tells a great deal about the country.
I wrote a book called Managing the Dragon in which I say that one of the things I learned early on is that Western companies tend to believe that high level introductions in Beijing will pave the way and are all that is important. Personal relationships are indeed important, but it is usually more important to make the right relationships at the local level. Yes, there are central directives, but China is decentralized. There is an old Chinese saying that covers this which states “ The mountains are high and the Emperor is far away”. So when I wrote my book, I had a chapter on decentralization, and that was the only one the censors wanted to eliminate. We were successful in keeping it in, but it shows that this is a sensitive subject in Beijing.
Since WWII global recessions have generally been resolved through increases in consumer and industrial demand from the US. This time, however it was led by demand, infrastructure spending and stimulus from China. How real and sustainable is the emergence of China as a platform for consuming demand?
China has a lot of wealth. It is not just at the top level since most people have in some way participated. There has been enormous creation of wealth and this enables people to spend. The government has also taken steps to bolster the social safety net so that ordinary citizens don’t have to save quite as much. As part of its stimulus package, China included incentives for consumption, for example, to promote conventional vehicles for farmers—China’s own version of a cash for clunkers program. China also passed a new labor law at the end of 2007, which is leading to wage increases and a better standard of living across the country. All of these factors are leading to a larger consuming class that is gaining in size and purchasing power. This is a story for the future. When you look at most products, China is already the largest market in the world. In autos, for example, China will produce over15 million vehicles in 2010. Virtually all of these are for internal consumption. This year, the US will produce about 12 million by comparison.
Economic size does not necessarily translate into quality of life and while the aggregate size of China is huge there is still a huge gap in per capital income distributions. What about income inequality? Environmental problems? Demand for democracy?
China has enormous problems. It has industrialized in a short time, creating many issues. Air quality is poor; there are water shortages; and lots of pollution. You may also be reading about heavy flooding because China has not in the past paid adequate attention to conservation, creating serious problems with erosion. China’s environmental issues are big, but I don’t think they are big enough to stop the economy in its tracks. That said, they definitely will need to be dealt with, and that is one of the country’s challenges.
At present, there does not seem to be great demand on the part of ordinary people for Western style democracy. In effect, they have outsourced the management of the country to government, and so long as the government delivers growth, the people are happy. I’ve been in China since 1993, and while the quality of life is still not as good as in the US, the change has been dramatic. I think that China will continue to progress positively in the future.
In my view, the shift from viewing China and Asia as a production platform to one that represents an emerging source of growth is perhaps the biggest challenge for US companies moving forward and we have done a fair amount of work in this area. Managing sales, operations and distribution in these markets is far more challenging than production facilities. How can US firms, particularly small to medium-sized operations take advantage of this phenomenon?
The biggest and only reason to be in China now is the market. When we set up ASIMCO, we set it up not for export but for the domestic market. It is absolutely right that it is challenging. China is perhaps the most difficult place in the world to do business. You need to localize management and develop a local strategy and in effect create a Chinese company. That is challenging. Large or small, however, does not make a difference. You need to make China familiar, and in some ways smaller companies have an advantage, as they can be more flexible. Larger firms tend to bring people over from HQ with an established plan and strategy. That is a good place to start, but it has to be altered for the China market. That takes time and an understanding of local practices and culture.
For example, take a look at Toyota and how they have managed their US expansion strategy. Aside from the current quality issues, you can see what Toyota has done in the US. They have in effect become a US company with local managers. That is what companies need to do in China.
There is also a lot of talk about the “smiling curve” in which China had been concentrating on production but leaving higher value activities such as R&D and distribution and marketing and distribution to firms such as Apple, which generate much larger profits. Now Chinese firms are also starting to build brands. Another perceived problem in the US is we are not generating enough engineers and are letting our educational system deteriorate. Any thoughts?
What you describe about Apple portrays one slice of the Chinese economy, but does not tell the whole story. And, China is changing. The Chinese economy was built on low wages, but it is now expanding and companies are moving up the value chain. Haier, Lenovo and BYD are just three examples. Moving upstream and creating brands takes time, but it is happening, and we will see more activity and sophistication on the part of Chinese manufacturers in the years to come.
There is no question that education is important. Engineering is also a popular path in China. What does China’s development mean for the US? I don’t think it is a zero sum game as many believe. If there are more people figuring out a cure for AIDS, that is good for everyone. I am a believer in the US. Having spent close to twenty years on Wall Street, I have a great respect for its efficient capital markets and ability to allocate capital to new ideas.
We are starting to see wage pressures in China in addition to ongoing concern over currency exchange rates and the impact of China’s growth on global commodity prices. At the same time Japan and many now believe the US and parts of Europe are facing a deflationary environment. How important are currency exchange rates, what can be done and how can these conflicting macroeconomic pressures be reconciled?
There is a lot of pressure on China over currency and China did de-peg from the US dollar on June 19. While the renminbi has appreciated by just over 3% against the USD since then, the Euro, the Yen and the British Pound have all increased by 15% or more. The reason is that China has switched to buying more assets denominated in these other currencies. That means that US manufacturers have a stronger position against these other manufacturers than in the past. The concern over currency in any case is overrated as a cure for US competitiveness. Any rise in China’s currency will only. reinforce the shift to higher value added products where China can be even more competitive.
China has an increasingly complex economy with a multitude of opportunities and sectors. Where do you see the best opportunities moving forward? What should be avoided?
Anything that has to do with the environment, healthcare and education all have plenty of potential. Distribution and consumption-oriented businesses do as well. As far as areas to avoid? I think the days of export driven businesses hold less promise than in the past.
Intellectual property has been a major problem in China and there is a general perception that the legal environment is arbitrary which makes planning and enforcement on a range of issues difficult to impossible particularly if you become “too” profitable or come into conflict with government authorities. We also hear a lot about the importance of relationships when doing business there. How do you view this issue and what would you advice companies who are just entering the market?
Relationships are indeed important. That does not mean you need to have them when you get to China, but you do need to form them and use them rather than legal means to enforce your goals and interests. Concern about intellectual property is a question I get all the time. I think the actual situation is much better than most people believe. That does not mean it is not a problem, but it is not as bad as most think and it is certanly better than in the past. For Business to Business deals there are ways you can protect yourself in terms of how you structure your manufacturing and produce your products. China is also innovating more, and the more that happens, the more the country’s local companies will be interested in protecting their intellectual property. At the moment, China is already one of the top holders of patents in the world, and that will significantly change the way the country views intellectual property rights over time.
Any thoughts on the potential for foreign direct versus portfolio investment?
There are not many ways to be an equity investor in China since you can’t buy “A” shares directly on the China market, though you can buy China plays through Hong Kong or US-listed ADRs. It is also possible to gain exposure indirectly through McDonalds and other multinationals active in China, but in relation to the size of the economy, there is a deficit in the supply of listed shares available to foreign investors and a lot of pent up demand. For now at least, foreign direct investment is a more meaningful option.
Thank you Jack for your time and attention. Before we conclude do you have any parting words for our readers?
A lot of people think that after 30 years of reform, it is too late to enter China. I disagree. I would argue it is only beginning in China, and that we are still early in the game.
This interview is part of an ongoing series highlighting Asia-related business, trade and investment opportunities and issues.
While the information and opinions contained within have been compiled from sources believed to be reliable, KWR does not represent that it is accurate or complete and it should be relied on as such. Accordingly, nothing in this article shall be construed as offering a guarantee of the accuracy or completeness of the information contained herein, or as an offer or solicitation with respect to the purchase or sale of any security. All opinions and estimates are subject to change without notice. KWR staff, consultants and contributors to the KWR International Advisor may at any time have a long or short position in any security or option mentioned.
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