China shakes the steel world

Shen Wenrong, the billionaire who bought Dortmund's Phoenix steel plant and moved it to the Pearl River, is increasing his hold on the privately-owned sector of the Chinese steel industry, as reported in SteelGuru here.

Readers of James Kynge's "China Shakes the World" will recall that Wenrong acquired Phoenix in 2004 partly in order to get into production fast, but also because, having bought it at scrap valuation during the last steel recession, he would not be encumbered with the debts that would wipe out his rivals in the next one.

Which means that he's looking beyond the next recession. And when the recovery comes, where will the West's capacity be found? Those who say that the East's fortunes are bound up with those of the West, had better get new spectacles to correct their short-sightedness.

Book Review: "China shakes the world" by James Kynge

This is a very well-written book: easy to read, vivid, informative and thoughtful about future trends. James Kynge has spent 19 years in Asia, half of that reporting from China, latterly for the Financial Times. His direct experience may be the most valuable aspect: he gives a sense not only of what the Chinese are doing, but their motivation.

This is an interpretive, sequential and selective summary, and I do suggest you buy the book - US Amazon link here (hard cover), UK Amazon link here (paperback).

It opens with the widely-quoted narrative about moving a steelworks from Dortmund, Germany to the Yangtse delta in China. The Chinese labour much longer and with less regard for health and safety than their European counterparts, shifting the plant in a third of the time originally expected, together with many tons of paperwork (rapid transfer of know-how is a major theme).

The purchase of the works was completed equally quickly, at a time when the Germans suffered high taxes because of reunification, world steel demand was depressed, and South Korea was undercutting their prices. But Kynge notes that had the owners waited until 2004, the recovery in the market would have made the works profitable again, even in Dortmund. A battle lost through failures of nerve and foresight?

The new owner, self-made billionaire Shen Wenrong, had now bought himself a ready-made plant at scrap cost. This got him into production faster, but also with less debt, an advantage which will tell when the next downturn comes - which Shen expects to happen soon.

The Chinese economic reforms that started in 1978 have seen many rags-to-riches stories. The Party hadn't officially sanctioned private enterprise on such a scale, but local officials turned a blind eye for the usual reasons - corruption and ineffective central control are other motifs in this story.

China has leapt from village and farm to city and factory at warp speed. This means that there is a vast pool of eager, cheap labour for its new industry. There is also a great and growing demand for resources, not only for manufacture but also for city construction, road and rail development, and energy production.

The move from handwork to brainwork means education is very valuable - a later chapter gives an example of identity theft merely to secure a college place, which then helps the thief into white-collar work and a far higher standard of living. For the Chinese, elitism is the way to excellence; Kynge writes of a Shanghai school principal's amazement at Britain's assaults on selection in education. Chinese who can afford it are buying the best foreign private schooling - Dulwich College has opened subsidiaries in Thailand and China.

China has a huge population, with a per capita income of slightly over $1,000 a year. Although its people are racing to catch up with our living standards, demographics will impact on the economy: by 2040 one-third will be over 60 years of age. Kyng says, "It may be that China grows old before it is rich." Like Alice and the Red Queen, China has to run just to stay put - the country has to create 24 million new jobs each year, or face the social and political consequences of a stall.

So the pressure is on. Many companies have copied designs and technology e.g. from the Japanese, and then from each other, setting up rival concerns and increasing production to the point where the profit margin disappears. But the result is not bankruptcy - the government has decided that employment is more important than Western-style financial probity. Besides, there's lots of money available for commercial lending: Chinese people save around 40% of their incomes. Since the domestic market is oversupplied, the Chinese look to make a profit from exports, deflating the global market in manufactures.

Intellectual property rights are not a priority in this scramble. The author visits Yiwu, a great market for pirated goods, and when he calls the anti-fakes hotline he gets the runaround.

What about the quality originals? He visits Prato, Italy, to see the ancient textiles centre; it's been hit hard. First, Chinese arrived as cheap immigrant labourers; then Italian firms began to import materials from China; then they started to get the work itself done over there; finally, Chinese firms set up and took over, appropriating pattern books that took centuries to develop.

The tale is the same with silk, in Como, and jewellery, in Chiasso. "In many areas of manufacturing, European companies cannot compete in the longer run - no matter what counter measures they or the EU may take." White collar workers are not safe, either: their work is also migrating to India and China: "...accounting, law, financial and risk management, healthcare, information technology and several other service areas."

European workers cost too much: pay, healthcare, unions. And their governments are too expensive: Chinese state expenditure as a percentage of GDP is less than 50% of German levels. But European countries are democracies, so tough economic action is politically difficult; whereas in China, it was possible for them to lay off 25 million workers in state-owned enterprises in 1997-2002, and 120 million migrant workers receive no welfare at all.

To the USA: Rockford, Illinois, the centre for machine tools. The Chinese government is overwhelmingly composed of engineering graduates, and they want Western tools, blueprints and know-how. They bought Ingersoll Production Systems and used the firm to try to acquire Ingersoll Milling Machine, which has key technologies for rockets, nuclear power stations and stealth bombers. The US government and its intelligence services were quite unaware, until tipped off by locals. Now, American machinists who used to earn $16/17 per hour are working in retail for $7 per hour, with no pension.

Eric Anderberg of Dial Machine tells the author how the world is not flat, but tilted against America: China has an undervalued currency, little welfare for workers, no labour unions, cheap credit from the state banking system, loan defaults without consequences, VAT rebates available to exporters but not US companies, lax environmental emission controls, intellectual property theft and little enforcement of IPR rights, state-subsidised input costs such as electricity and water. And then US bureaucracy and legislation adds some 20% to American business costs.

Kynge learns all this at the local annual Chamber of Commerce dinner, where Al Frink, the US President’s manufacturing “czar”, is to speak. The dismayed audience then hears Frink talk in favour of outsourcing. The author notes that what hurts Anderberg suits the big US corporations, who earn 25% of their profits from foreign subsidiaries; for example, IPR theft saves on overseas R&D. Anderberg remarks that “Lenin said that America would tear itself apart from the inside through greed.”

Kynge turns back to a coal mining area in China, to illustrate her difficulties. Industrialisation is creating health-wrecking air and water pollution. There is a shortage of usable land, and the deserts are advancing. China is gobbling up resources and commodities, especially oil. There are environmental limits to growth: using the measure of a “green GDP”, i.e. economic growth minus resource depletion and environmental degradation, Shaanxi province has made virtually no progress in the last 20 years. Besides, China’s vast population can never have a standard of living like present-day America – the world does not have the resources.

The pressures are breaking down the bonds of mutual trust and obligation. Identity theft; bogus police; cash-stuffed envelopes for journalists; corrupt and immune officials; sexual infidelity; lethal, fake baby milk powder; HIV-infected blood plasma. And from the West's standpoint, there is an image of political oppression, unfair terms of trade, supposed worker exploitation.

So China has a brand image problem that affects its foreign trade. But if China can crack this, she will enjoy another great leap forward. For the worst exploitation of its workers is not by the Chinese themselves: "... all of the work done in China - the sourcing, manufacturing, transportation and export - rarely qualifies for a return of more than 10 or 15 per cent from a product's sales revenue." Most of the money is being made in advertising, marketing and sales., and when the foreign consumer no longer thinks it uncool to buy openly from the Chinese, the latter will reap much greater benefit from their labour. (Perhaps there are some questions to be asked about the markups and fees of Western middlemen.) We shall have to see how the Olympics changes perceptions. Meanwhile, established brands are being used as the marketing wrapper for Chinese work, e.g. Lenovo's purchase of IBM.

Doubts about China are not merely a matter of perception. The country is trying to move to a capitalist economy, but retain centralized Party control. So when companies get stockmarket listing, typically they float less than a third of share capital, keeping ultimate control for their own management. There are lax disclosure rules and company figures have not infrequently been falsified. The "big four" banks are State-owned, run by Party officials and burdened by bad debt. Kynge guesses it could cost up to $500 billion to clean up the financial system. There is also corruption - he gives as an example oil wells in Shaanxi, developed by private investors and then arbitrarily confiscated by local officials, who may well have benefited personally; but appeals to the local courts are pointless, since the judges are appointed and paid by the same officials. There is some hope: in March 2003, the national Constitution was amended to give private property the same status (in principle) as Party property - but government accountability is still in its infancy.

The author concludes with a chapter on China's relations with outsiders, which are coloured by the events of the nineteenth and twentieth centuries. The desire for economic progress is sometimes in conflict with impulses of national pride, power and prestige. Now that she is becoming mighty, China is choosing her own friends, and is in uneasy relationships with neighbours such as Taiwan and Japan. As America's balance of trade worsens, China may have more than one reason to give more weight to its own need for economic development than to harmonious foreign relations.