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CHEUNG KONG
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K N O W L E D G E
Volume No. 31
Fall 2018 $12.00

THE tourism deficit

High-spending travelers are pushing China toward a current account deficit

· Kishore Mahbubani on the future of US-China relations

· The robot revolution sweeping through China’s e-commerce supply chain
· The small Chinese phone maker with a big Africa strategy
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Table of Contents Fall 2018

Comment Tom Miller, Senior Asia Analyst at 14

Gavekal, explains why China’s global
The Other Side of AI 6 development plans are misunderstood
47
History should make us cautious as we
begin a new industrial revolution, argues
Professor Xu Chenggang 17
Economy and Policy

Mending China’s Data Fences 47

Online data theft is rife. Can new privacy
rules fix the problem?

Betting All the Chips 17

Dancing to a New Beat 9
The Belt and Road Initiative is changing
rapidly
Why Beijing is betting big on semiconductor 52
technology
When the Taps Run Dry 21
Water shortages threaten cities across
northern China
Trading Places 25
Is China heading for a current account
deficit?

Issue: Fall 2018

Vol. No. 31 32
Editor-in-Chief Hans Tung, Managing Partner of GGV 52
Zhou Li Capital, explains China’s ties with Silicon
Valley
Senior Editor
Greg Langley Company
Managing Editor
Dominic Morgan Africa Calling 55
How little-known tech firm Transsion came
Coordination
Mei Xinlei, Liu Sha
to dominate Africa’s phone market

Design Business Barometer

Jason Wong
Business Barometer 60
Cover The latest data on how the US-China trade
Wei Bingnan Kishore Mahbubani, former United 32
Nations Security Council President, discusses war is impacting the economy
Produced By the future of US-China relations
SinoMedia Downtime
Business Trends The Big Cover-up 64
ISSN 2312-9905
Publisher Delivering the Future 35 The tattoo industry is flourishing, but it is
also provoking a backlash
CKGSB GLOBAL LIMITED China’s e-commerce industry is pushing
Suite 3203, 32/F, Champion Tower, automation to the next level China Data 68
3 Garden Road,
Eddy Chan, Head of China at FedEx, 39 The Chinese economic trends you may have
Central, Hong Kong
discusses the future of global logistics missed: from sea cucumbers to casino centers
For Letters to the Editor or reprint requests, Bookshelf 70
Not a Hollywood Ending 43
please contact: Kerry Brown, Professor of Chinese Studies
ckgsb.knowledge@ckgsb.edu.cn US blockbusters are facing greater at King’s College London, selects his favorite
competition from domestic films China books

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Letter from the Editor Fall 2018

A Fork in the Road

“
The old world is dying; the new leading smartphone maker. “Delivering

CKGSB
world struggles to be born,” CHEUNG KONG the Future” (page 35) documents the
Antonio Gramsci wrote. The Italian GRADUATE SCHOOL
OF BUSINESS robot revolution sweeping through China’s
philosopher was discussing Europe during K N O W L E D G E warehouses. And “Not a Hollywood
Volume No. 31
FALL 2018

the early 20th century, but the phrase Ending” (page 43) goes behind the scenes
$12.00

appears just as apt when considering East
Asia nearly a hundred years later.
This is a time of huge uncertainty for
the entire world, but even more so for
China. How to deal with the turbulence
roiling the global trading system is only
one of several epoch-defining decisions
facing Beijing. Even greater issues are how
the country manages its transition from
a peripheral country to a world power,
and from a low-end manufacturer to a
technological leader. In this issue, we will
High-spending travelers are pushing china toward a current account deficit
of China’s booming domestic movie
industry.
And in our Downtime story, “The Big
Cover-up” (page 64), we take a peek at
China’s flourishing tattoo industry and
the culture clashes it is creating between
millennials and the more conservative
older generations.
We also feature some fascinating
interviews in this issue. Hans Tung,
Managing Partner of GGV Capital,
THE Tourism dEficiT compares the US and Chinese venture

dive into the fray and analyze how China is capital scenes (page 52). Eddy Chan,
· Kishore Mahbubani on the future of US-China relations

handling these struggles up close. President of FedEx China, discusses the

· The robot revolution sweeping through China’s e-commerce supply chain
· The small Chinese phone maker with a big Africa strategy

A sign of how quickly the economy is future of the logistics sector (page 39).
changing is the country’s falling current Kishore Mahbubani, Professor of Public
account balance. Despite running a $375 billion trade surplus with Policy at the National University of Singapore, considers the
the United States, China actually posted its first quarterly current future of US-China relations (page 32). And Tom Miller, Senior
account deficit since 2001 this year. In “Trading Places” (page 25), Asia Analyst at Gavekal Research, explains why China’s overseas
we explore what that means for the global economy. development strategy is misunderstood (page 14).
One of the key contributors to the deficit was China’s dependence In other words, there is plenty in this issue to think about and
on foreign microchips, which are now a larger driver of imports to discuss. As usual, if you have any comments or opinions to
than crude oil. Beijing is determined to build its own world-class contribute, we would love to hear from you (lzhou@ckgsb.edu.cn
semiconductor industry, but so far things are not going to plan, as or ckgsb.knowledge@ckgsb.edu.cn).
“Betting All the Chips” (page 17) outlines.
Another policy at a crossroads is the Belt and Road Initiative,
the $1 trillion transcontinental development strategy launched by Yours Sincerely,
China in 2014. Beijing considers the initiative central to its policy
goals, but can it overcome increasing pushback from overseas? Find
out in “Dancing to a New Beat” (page 9).
In the online world, governments also face a delicate balancing
act: how to protect users’ data without harming the development
of emerging industries like artificial intelligence. Brussels and
Washington are divided over the issue. “Mending China’s Data
Fences” (page 47) looks at where Beijing stands. Zhou Li
“When the Taps Run Dry” examines a more pressing issue, Assistant Dean, CKGSB
which is water scarcity in northern China. With rivers drying up Editor-in-Chief, CKGSB Knowledge
across the country, are drastic measures needed? The answer is both
yes and no, as we explain on page 21. For more insights on the Chinese economy and business, please
On a lighter note, this issue also highlights three unsung success visit the CKGSB Knowledge site: http://knowledge.ckgsb.edu.cn/
stories. “Africa Calling” (page 55) chronicles the unlikely rise
of Shenzhen-based tech company Transsion to become Africa’s

CKGSB Knowledge 2018

/5
Comment
The Other Side of AI
Previous industrial revolutions show that blindly embracing new technologies leads
to disaster. We must heed that lesson during the transition to Industry 4.0
T
he negative effects that industrial
revolutions unleash on human society
always stem from an overestimation
and abuse of the power of new technologies.
It has never been more important to heed
this point than today. Big data and artificial
intelligence (AI) are bringing forth a new
industrial revolution, and the blind worship
of these innovations is already on full
display in some quarters.
In early September, Russian President
Vladimir Putin said that the development
of artificial intelligence technology has
created “huge and unpredictable new
opportunities and threats.” “Whoever
leads this field will rule the world,” Putin
declared. In the Russian leader’s eyes, AI is
not only a major strategic opportunity, but
the key to his country’s survival.
China is also keen to lead the way in
AI. On July 8, the State Council issued the
“New Generation Artificial Intelligence
Development Plan.” Promoting the
development of the AI sector is of course
a very good idea, but the crucial question
6 / CKGSB Knowledge 2018
By Professor Xu Chenggang
is, how best to do this. Is it, as some have
suggested, through state planning? To
that question, we can answer with great
certainty: the planned approach will not
work. Those who use the planning method
can only follow in the footsteps of others,
which implies that they will lag behind.
In the history of mankind, all
technological revolutions, all moments of
revolutionary innovation, have emerged
from the market and from entrepreneurs
acting on private initiative. They are
the final result of survival-of-the-fittest
competition.
In the hot debate about AI, some
prominent figures have asserted that
artificial intelligence could be capable
of producing a new form of planned
economy. One example they cite is the
financial sector, an important application
field for AI. Since investment decisions can
be made by machines, isn’t this a form of
planned economy?
Where the boundaries of the planned
economy should be has therefore re-
emerged as an important and fundamental
question for the future.
The Problems Are Institutional
Before answering this question, the first
thing I would emphasize is that China’s
biggest problems are systemic and
should not be thought of as an assortment
of technical issues that can be fixed
individually. Ultimately, it is not important
whether China is a global leader in this
or that industry. The important thing is
whether the national economy as a whole
is doing well.
Last year, a survey by McKinsey
found that China’s labor productivity is
only 15-30% of the average among the
OECD countries. This means that China
is still several times less productive than
the developed nations. There is a general
backwardness in China’s economy that
dwarfs the progress in a few cutting-edge
fields.
Labor productivity is low, but at the
same time labor costs are very high. In

2016, unit labor costs in China were higher
than in the United States and Western
Europe, according to analysis by the
Economist Intelligence Unit. An Oxford
Economics survey conducted the same year
found that China’s labor costs were only
4% lower than in the US. In other words,
if we are looking purely at labor costs, it is
now more expensive to make a product in
China than the US. This is strange.
If labor costs are so high, does this mean
that Chinese workers are earning too much
money? No. China’s household income
accounts for only slightly more than one-
third of China’s gross domestic product
(GDP), the lowest level in the world. In
most other countries, household income
takes up more than half of GDP, so China’s
workers are not getting much.
Labor costs are high; workers don’t get
much money; enterprises bear a lot of the
costs; and the enterprises themselves are
not getting much either. How can all this
be true? The answer is that the government
is taking all that money for itself. The
government’s fiscal revenue growth rate
has been growing faster than GDP for more
than 20 years, and it still is today. The
Chinese government’s income is the highest
in the world, and this causes workers and
enterprises to bear huge institutional costs.
Systemic issues like these are the ones
we need to solve. We can focus on fixing
technical issues in the Chinese economy,
such as upgrading traditional industries by
integrating new, cutting-edge technologies,
and these efforts are sure to produce
positive results. But they cannot solve the
wider economic problems we face.
What’s more, industrial upgrading has
the potential to create negative as well as
positive effects.
Lessons from the Industrial
Revolution
When people mistakenly believe
that the latest scientific and technical
breakthroughs surpass all the knowledge
accumulated by humanity over thousands
of years, they sometimes rush to replace
the socio-economic systems produced
in recent centuries, which often leads to
disastrous results. There is a consensus
Some governments and large,
monopolistic companies may try
to use their mastery of big data to
control society and replace the market
is that the emergence of big data and
artificial intelligence are leading to another
industrial revolution. But when discussing
where these changes will lead us, we need
to look calmly at the many negative lessons
from past industrial revolutions, relating to
the overestimation and abuse of the power
of new technologies. Industrial revolutions
are not always positive in all respects and
we must be wary of the possible dangers
involved.
One of the worst lessons from previous
industrial revolutions is the creation of the
state ownership-dominated central planning
system. This idea was first produced
during the first two industrial revolutions.
At that time, some ultra-left intellectuals
mistakenly believed that human beings
had acquired the ability to understand
everything, and that they therefore had the
ability to control all aspects of society.
The mistaken belief that the social
planner is able to know what is good for
everyone, can take care for everyone’s
welfare, and can plan as well as implement
the plan for every technological change,
all production and everything: this is the
underlying idea leading to central planning.
Because there had never been an industrial
revolution before in human history, some
intellectuals overestimated their own
power and this led them to abuse it. At its
height, one-third of the world’s population
lived in state-owned and centrally-planned
economies.
Another common problem arising from
the hubris of intellectuals is environmental
destruction. There are two clear examples
of this. The first is huge water conservancy
projects. People think that they have the
ability to plan the system of rivers, lakes
and land. They build dams to make huge
Fall 2018
artificial lakes. Then, when this produces
catastrophic consequences, they realize that
there are a lot of things they don’t know.
Even if a government with huge resources
and power has good intentions, it can still
create disasters.
A second example is climate change,
a problem that did not exist before the
industrial revolution, and the cause is the
same—people mistakenly believe that they
are smarter than they are. When Hurricane
Irma swept through the Caribbean, with
wind speeds reaching 300 kilometers
per hour, 95% of the buildings on some
islands were completely flattened. This
natural disaster was man-made. The
cause was people who believe that we
could concentrate all resources on solving
society’s problems. But in the process, so
much carbon was emitted from fossil fuels
that the climate has been destabilized.
These old lessons are still far from
being fully absorbed, but the big data and
AI revolution is coming. Some scientists
have issued warnings, but most focus on
ethical issues like the possibility of using
robots in warfare. I want to emphasize
another problem, that of the system and the
relationship between the market and the
central plan.
Some governments and large,
monopolistic companies may try to use
their mastery of big data to control society,
to replace the market, to curtail free
speech—to use technological progress
against society. It would bring disaster to
society. We must rather make sure that this
industrial revolution truly benefits
mankind.
Xu Chenggang is Professor of Economics
at CKGSB
CKGSB Knowledge 2018
/7
 Fall 2018

Dancing to a
New Beat
The Belt and Road Initiative is
changing rapidly as it matures

Image by Wei Bingnan By Jens Kastner

CKGSB Knowledge 2018

/9
Economy & Policy
The Belt and
W
hat a difference a year makes.
Last summer, there was a sense
Road Initiative of unstoppable momentum behind
the Belt and Road Initiative (BRI), China’s
has run into trillion-dollar plan to build a network of
infrastructure connecting Africa, Asia and
trouble this year Europe.
When China hosted its 2017 Belt
as rising debt and Road Forum, 29 heads of state and
delegations from another 100 countries
burdens weigh traveled to Beijing, hoping to cash in on
what President Xi Jinping described as the
down China’s “project of the century.”
This year the landscape, at least from
partners. Beijing the media’s perspective, looks dramatically
different, as even China’s closest partners
has reacted by make more cautious noises about the
BRI. Some have even suggested that the
launching a range initiative is not a road to riches, but a “debt
trap” set by China to gain influence and
of reforms that seize strategic assets from smaller nations.
In May, China skeptic Mahathir
will significantly Mohamad won power in Malaysia in a
shock election victory over Beijing ally
change the Najib Razak. Within months, the new
prime minister nixed $23 billion worth of
nature and scope BRI projects, warning of the dangers of a
“new form of colonialism.”
of the initiative Recent elections in Pakistan and the
Maldives followed a similar pattern,
with opposition leaders Imran Khan and
Ibrahim Mohamed Solih ousting China-
friendly incumbents. Khan’s government
has already sought to renegotiate loans for
billions of dollars’ worth of projects with
Beijing.
A chorus of Western criticism has
added to the sense of crisis, with figures
including Christine Lagarde, head of the
International Monetary Fund (IMF), US
Treasury Secretary Steven Mnuchin and
former Secretary of State Rex Tillerson all
warning of the dangers of China’s lending
practices.
As the fifth anniversary of the BRI
approached, there was speculation that
Beijing might quietly dial back the
initiative. But in August, President Xi made
clear in a high-profile speech at the Great
Hall of the People that the policy remained
central to his administration.
In the wake of the speech, the media
narrative has become one of confrontation
10 / CKGSB Knowledge 2018
between Western critics and a defiant
Beijing. But this assessment may prove
wide of the mark. In fact, China is aware of
the risks building over debt and has already
initiated reforms designed to set the Belt
and Road on a more sustainable path.
Debt Debate
Concerns over debt sustainability were
always going to be baked into BRI given
the nature and scale of the projects it
encompasses.
Chinese banks have loaned more
than $200 billion for 2,600 projects since
2013, the China Banking and Insurance
Regulatory Commission estimated earlier
this year. This is already far more than the
total US aid given out under the postwar
Marshall Plan, which would be worth
around $135 billion today. Around $900
billion of projects are planned or underway
in total, according to credit rating agency
Fitch.
Whereas the Marshall Plan was for US
allies in Western Europe, the BRI targets
developing countries, including many in
the highest-risk areas in the world. Of the
70 countries that had joined the initiative as
of August, 27 had sovereign credit ratings
of “junk” from the three main global ratings
agencies, while another 14 had no rating at
all.
The largest basket of projects, the
China-Pakistan Economic Corridor,
comprising $62 billion of industrial,
power and transport infrastructure, runs
through the troubled Pakistani province of
Balochistan, where a guerrilla war between
local insurgents and the government is
ongoing.
Building infrastructure can provide an
effective platform for growth for developing
countries. Ethiopia, for example, has grown
at an average of 10% per year since 2008
thanks largely to infrastructure investment
backed by China. But the sheer amount of
funding on offer from China has led some
countries to run up large amounts of debt,
putting public finances under pressure.
In sub-Saharan Africa, average public
debt levels rose from 34% of gross domestic
product to 53% between 2013 and 2017.
Debt service as a share of public revenues
 Fall 2018

DANGER ROAD Many BRI countries have low credit ratings

Total lending
by Chinese
$200 banks to BRI
projects so
billion far

Countries

71
that have
joined the
BRI as of
August

BRI

41
countries
Minimal, very low or low risk Substantial, high, or very high
with “junk”
Moderate Not currently rated or no credit
Source: Chinese government; Bloomberg (ratings based on average from Fitch, Moody’s and S&P) rating
has doubled, according to Geneva-based unstable countries.”
nonprofit International Centre for Trade Even before the BRI kicked off, China
and Sustainable Development. was making loans to developing countries.
Pakistan has seen its external debt Between 2000 and 2014, China lent

skyrocket by 50% over the past three years
to nearly $100 billion, around 30% of
which is owed to China. The country is now
facing a balance of payments crisis, with its
foreign exchange reserves dropping to just
$10 billion by the end of June.
The Centre for Global Development,
a US think tank, has also expressed
75%
Percentage
$354 billion and 75% of these loans had
of loans on
commercial terms, according to researchers
commercial
at William and Mary University in the
terms
United States. BRI countries take these
deals because other countries are not
willing to lend to them, while multilateral
lenders like the IMF and World Bank often
demand governance reforms and take much

“serious concerns” about the sustainability
of sovereign debts of seven further BRI
countries: Djibouti, Kyrgyzstan, Laos,
Maldives, Mongolia, Montenegro and
Tajikistan.
The chance of default is high because
China tends to offer financing with
commercial interest rates to offset the risks
involved in the projects. “Lending to BRI
89%
longer to dispense funds. Projects
China is also willing to hand over more using a
capital at a lower rate than commercial Chinese
banks. When Djibouti was building its contractor
Doral Container Terminal, it started by
borrowing $268 million from seven banks
at a 9% interest rate payable over nine years.
Then China offered an additional $620
billion at 2.85% over 20 years, according Infrastructure

$26
countries comes in a combination of aid and to Aboubakar Omar Hadi, chairman of the investment
commercial loans,” says Su Yue, an analyst Djibouti Ports and Free Zones Authority. needed for
at the Economist Intelligence Unit (EIU) But even at a lower interest rate, trillion developing
Asia by 2030
in Beijing. “China’s lending has more borrowing at this scale can easily tip
flexibility for commercial purposes, and countries into financial trouble. First,
interest rates reflect the risk of operating in returns on infrastructure investments tend

CKGSB Knowledge 2018

/ 11
Economy & Policy
Workers perform maintenance on the Chinese-built Addis Ababa-Djibouti Railway
in Ethiopia
to come over a long timescale, while the to describe Beijing’s alleged technique.
loans are sometimes payable within a few Fears spread that other countries owing
years. Second, if the projects turn out to China significant sums might be forced into
be a commercial failure, the situation can similar surrenders of sovereignty.
quickly become severe.
This was the case in late 2017, when Sri Road Maintenance
Lanka defaulted on repayments for loans But there is little evidence at this point to
used to finance projects including a port in suggest that the Hambantota deal will be
Hambantota. The port cost over $1 billion, the rule, rather than an exception. As W.
but was incurring significant operating Gyude Moore, a former Liberian minister,
losses. pointed out in Quartz in September, China
In return for debt relief, Sri Lanka has restructured or waived loans without
agreed to hand over the port to Beijing on taking control of assets 84 times in the last
a 99-year lease. This was controversial, 15 years.
with many accusing China of intentionally There has also been a noticeable change
miring Sri Lanka in debt in order to gain a in mindset from China, with the focus
strategic foothold in the Indian Ocean. shifting from lending as much as possible
The Indian scholar Brahma Chellaney to ensuring that projects are workable.
coined the phrase “debt-trap diplomacy” “In the first two years of BRI, we saw
In 2017, we saw efforts by the Chinese
government to better control overseas
investment and that helps make BRI
more mature
Nick Marro
Analyst, Economist Intelligence Unit
12 / CKGSB Knowledge 2018
lots of activity often resulting in projects
that were not very sustainable,” says Nick
Marro, a China analyst at the EIU. “In 2017,
we saw efforts by the Chinese government
to better control overseas investment and
that helps make BRI more mature.”
Many assume that BRI is a grand plan
masterminded from Beijing, but the reality
is that the initiative was almost a free-
for-all during its early stages. Yuen Yuen
Ang, a professor of political science at the
University of Michigan, describes BRI
as a typical example of a Chinese-style
“mass campaign,” where “everyone pitches
in with frenzied enthusiasm and little
coordination.”
As Ang notes, there is still no government
department devoted to directing BRI, only a
small “leading group” made up of ministers
from various offices. The group’s action
plan is just seven pages long.
The dynamics of a mass campaign often
leads to officials signing as many deals
as possible in order to impress superiors,
with little concern for whether the deals are
likely to be successful long term. Beijing
now appears to be attempting to counter
this tendency.
In 2016, the State Council toughened up
standards for state-owned enterprise (SOE)
managers: should they make investments
that go bad, they could face disciplinary
action or criminal charges—even after
they have retired. According to Deloitte,
the government has also tightened scrutiny
of prospective deals and introduced
restrictions on the areas in which Chinese
companies can invest.
These changes seem to have an impact.
In the first five months of 2018, Chinese
companies signed $36.2 billion worth of
BRI contracts, down 6% year-on-year,
according to data compiled by The New
York Times.
The rhetoric coming from China’s
leaders reflects this more cautious attitude.
“Ensuring debt sustainability—that is very
important,” said Yi Gang, the new governor
of China’s central bank, at a conference in
April.
“Resources for our cooperation are
not to be spent on vanity projects but in
places where they count the most,” Xi

Jinping told African leaders at the Forum
on China-Africa Cooperation (FOCAC) in
September.
This year’s FOCAC also highlighted
how Chinese funding is skewing toward aid
rather than commercial-style loans. In its
latest $60 billion package of financing for
Africa, China offered $15 billion of grants
and interest-free or concessional loans, up
from $5 billion in 2015.
Reform and Opening
The next phase looks set to bring BRI
further in line with international standards.
This could lead to fundamental changes
in the way the initiative operates. Beijing
appears to understand that the darkening
outlook for emerging markets means that
reforms are urgently needed.
“Current international conditions are
very uncertain, with lots of economic risks
and large fluctuations in interest rates in
newly emerged markets,” said Hu Xiaolian,
head of the Export-Import Bank of China,
one of China’s two state policy banks, in
July. “Our enterprises and Belt and Road
Initiative countries will face financing
difficulties.”
In August, Beijing issued policy papers
to SOEs involved in BRI projects covering
best practices in due diligence, project
feasibility and ongoing operations.
According to Deloitte, Chinese firms
involved in BRI are looking to reduce their
interest and exchange risks and financing
interest associated with long-term loans.
This is leading to greater involvement for
China’s financing of power and infrastructure
FALLING FUNDING
projects in BRI countries has declined since 2015
Volume of new projects
450
400
350
300
250
200
150
100
50
0 0
2012 2013 2014 2015 2016 2017
Source: RWR Data
Most tellingly, several major
Chinese institutions are stepping up
cooperation with multilateral lenders
Western banks and financing companies
and a more balanced portfolio of funding.
Most tellingly, several major Chinese
institutions are stepping up cooperation
with multilateral lenders. In April, Beijing
set up the new China-IMF Capacity
Development Centre (CICDC), which
has the aim of developing the capacity to
address implementation challenges on
issues arising from BRI.
“IMF is the acknowledged leader on
dealing with balance of payment crises,”
said Henry Chan, an adjunct research fellow
at the East Asia Institute in Singapore, in
August. “The new economic realities mean
that China must accelerate the learning
process.”
The two Chinese policy banks, Ex-Im
Bank and the China Development Bank,
are also discussing cooperation with the
European Bank for Reconstruction and
Development (EBRD) with a view to co-
lending with it. If the two sides agree a
deal, it would be a watershed moment,
as the EBRD would likely insist that co-
funded BRI projects adhere to international
standards, including the opening of bidding
Value of new projects ($ billion)
350
300
250
200
150 be willing to finance major infrastructure
100 projects without insisting that Chinese
50
2012 2013 2014 2015 2016 2017
Fall 2018
processes to non-Chinese contractors.
Using a Chinese company to carry out
projects has usually been a precondition for
Chinese loans. Research by the Center for
Strategic and International Studies (CSIS)
found that 89% of BRI projects used a
Chinese contractor.
“EBRD has a long experience of
financing projects, and a strong geographical
knowledge of the market it covers, and both
of these are clearly desirable for Ex-Im and
CDB, who wish to learn about them,” says
Agatha Kratz, Associate Director at the
Rhodium Group, whose research focuses
on Chinese outward investment and
infrastructure diplomacy.
As China focuses more on sustainability
and implementation, this opens up more
opportunities for global companies to get
involved by using their expertise to help
Chinese contractors navigate headwinds.
ABB, a Switzerland-based conglomerate,
helped 400 Chinese firms resolve inter-
country differences in design and industrial
standards in 2016 alone.
Gauff, a German engineering firm, is
working closely with Chinese SOEs on
several major African projects, including the
Maputo-Katembe Bridge in Mozambique,
which will be the longest suspension bridge
in Africa when completed. General Electric
has also received orders worth billions of
dollars through BRI projects and is bidding
for $7 billion worth of new business over
the next year or so, according to Deloitte.
The key question, according to Kratz of
the Rhodium Group, is whether China will
companies deliver at least part of them.
“That means making sure Chinese
banks’ participation really comes with no
strings attached,” says Kratz.
CKGSB Knowledge 2018
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Economy & Policy
Tightening Up the
Belt and Road
Pronouncements that the Belt and Road Initiative is failing are premature,
argues Tom Miller, author of China’s Asian Dream and
Senior Asia Analyst at Gavekal Research
T
om Miller is well-versed in the problems facing the Belt and
Road Initiative (BRI). He predicted many of them. In his
2017 book China’s Asian Dream, he warned that China’s
preference for cultivating close relationships with individual
leaders could be a long-term risk for BRI. Eighteen
months on, this looks prescient. New governments
have won power in Malaysia, Pakistan and the
Maldives, and renegotiating deals signed by their
predecessors are high on the agendas.
These setbacks have led to an avalanche
of negative press concerning BRI, with many
criticizing China’s lending practices and declaring
the BRI is doomed to fail. Miller explains it is far
too early to make that call.
Q. The media narrative on BRI has changed
recently. What is the status of the initiative?
A. If you see Belt and Road primarily as an
infrastructure-building initiative, which I do, then
it’s a very long-term initiative, and only at the beginning. Yet,
some in the investor world have already declared BRI a failure.
I think that’s silly as it is too early to judge. Many of the BRI
projects haven’t started yet or are still in the early stages.
In places like Pakistan, the things they have built are ‘early
harvest’ projects. That’s a weird Chinese term that means putting
basic infrastructure in place and implies the payoff happens
later. So far, they’ve built power stations, power grids and so on.
Pakistan used to have a massive electricity deficit and China has
been helping to solve that. Once you build the power grids, roads
and industrial zones, then investment can come in and hopefully
14 / CKGSB Knowledge 2018
the projects become a commercial success. Now, I’m not saying
that they will be a success—maybe the industrial zones will remain
empty. But it’s a fair point. You have to build the hardware first
and the return on investment comes later.
I have a bias here that comes from experience.
When China started building its high-speed rail
network in 2008, I thought this was excellent.
China needed it, and it was better to build it while
labor was cheap. But there were many, particularly
in the West who came out of banking and are
brought up to believe that all that matters is return
on investment, who were incredibly negative. They
saw it as a massive waste of money. Some still
argue that the high-speed railways have not made a
commercial return, but would anyone seriously say
that it has not been a phenomenal success? Such
schemes take time for the payoffs to be clear.
Q. At the moment, much of the criticism is
focused on China’s so-called ‘debt-trap diplomacy.’ What is
your view on this debate?
A. The question is whether China is deliberately setting out to
entrap countries. It is possible that there is such strategic thinking:
one of the aims of BRI is to create economic linkages that then give
China leverage. But I’m reluctant to say that China is deliberately
trying to entrap countries. Rather, I think this can naturally happen
when countries, like Sri Lanka, take on a huge amount of debt.
Of course, some will say that, whether it’s the aim or not, the
effect is the same and some in the Western press are labelling
China a ‘neocolonial power’ because of it, but I’m not convinced.

In the case of Malaysian Prime Minister Mahathir Mohamad, who
warned of a ‘new form of colonialism’ during a summit in Beijing
in August, I suspect that he was being politically clever. He’s the
new guy in power, clearly some dodgy deals were done in the
past and he wants to renegotiate to ensure the best outcome for
his country. But I’m not sure you can accuse China of colonial
behavior in Malaysia. Is it really colonial behavior to offer people
lots of money, and then when they say yes, to give it to them?
I think the more colonial attitude actually comes from Western
critics, who do not see these ‘small, pathetic countries’ as having
any self-determination capabilities. They are seen as simply
being unable to say no to China. I was recently at an event with
the Pakistani high commissioner in London, who became highly
irritated when someone put forth the argument that Pakistan
wasn’t capable of deciding for itself what it wanted.
Q. Does the pushback from countries like Pakistan and Malaysia
represent a long-term threat to BRI?
A. We’ll see what happens in Malaysia and Pakistan, but it’s too
early to say that China is being cut out of projects there. It’s worth
pointing out the example of Sri Lanka where something similar was
happening three years ago. A new government comes into power;
China had done dodgy deals with the previous administration; and
the new guys come in and say, ‘we want to clean this up.’
When I interviewed Sri Lanka’s finance minister, he told me
that they were going to renegotiate the loans and that they were
also going to obtain loans elsewhere. In the end they couldn’t
because nobody else wanted to lend them any money. Now,
they’re more beholden to China than ever before.
Critics will say that this is example of the debt trap, that it
was a deliberate ploy, but actually, Sri Lanka wanted Chinese
Renegotiating
loans in Malaysia
and other
countries is
positive—
not just for those
countries, but for
China too
Fall 2018
The Karakoram Highway cuts through northern Pakistan
investment. What they were annoyed about was the loans. They
wanted more equity investment, and now China is doing more of
that. The point is that China’s position in Sri Lanka is stronger
than before, and in that sense—from China’s point of view—it
has been a success.
Clearly, in some cases China has offered more money than
some countries can afford, but China is learning too. I personally
think that the renegotiation of loans in Malaysia and other
countries is positive—not just for those countries, but for China
too. Why would China want to throw away money on investments
that are not commercial?
Q. In China’s Asian Dream, you wrote that Chinese officials
privately admitted that they expected to lose 80% of the money
loaned to Pakistan for BRI projects. Does that still stand?
A. I got this from a good analyst, who said that someone well-
connected in Beijing told her this was the rule of thumb among
officials. I doubt that there is an official line, but it was the way
people in Beijing were thinking. It does tell you that there is a
strategic element to the China-Pakistan Economic Corridor
(CPEC). If you’re willing to lose money, it must be for a good
reason.
But I expect that equation changes for different countries.
There are strategic reasons to want a good grip on Pakistan. It
borders Xinjiang. And in Myanmar, where China wants access to
the Bay of Bengal, it may make strategic sense to lose money on
certain projects. But that might not be the case in Malaysia.
Pakistan is also different because China does not really have
allies, but Pakistan is as close as it gets. China has also been in
Pakistan for a very long time. Think of the Karakoram Highway,
which they built in the 1980s. Many CPEC projects have been
going on for a long time—long before President Xi Jinping came
up with the concept of the BRI.
CPEC could be incredibly useful for Pakistan. The problem is
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Economy & Policy
Xi Jinping announces a new $60 billion aid and investment package for Africa in Beijing in September
that China often goes overboard. It is pushing a Chinese investment
model that worked for China but has been incredibly wasteful and
inefficient. China has a particular political economy that allows it
to use this model without collapsing, but partner economies are
different: they will not be able to absorb that kind of money in the
same way.
Q. To what extent have China’s investment and lending practices
changed since BRI began in 2013?
A. In a way, not much. China has been doing all this for a long time,
particularly in countries like Venezuela. I guess the difference is
that China is not lending for resources. There has been a shift over
the last decade. Now, they are doing it because they have expertise
and can build stuff, and Chinese companies can do well out of it.
They’re also trying to create economic partnerships, and through
that suck countries into their economic orbit.
In terms of the way loans are structured, it’s very opaque. But
one thing that is changing is that China is moving more toward
concessionary loans, loans with substantially more generous terms
than market loans. Based on data compiled by William and Mary
University, I also calculated that China’s aid disbursement was
around $100 billion between 2000 and 2014. During that period,
the US gave out $366 billion. China still gave out a lot of aid, but I
think you’ll see more coming from China in the future.
At the National People’s Congress this year, Beijing
announced a new International Development Cooperation Agency
and said that they want to classify foreign aid as an instrument of
great power diplomacy. It sounds as though they have decided to
behave more like the big developed countries do.
Q. There were some negative comments in China following
the announcement of a new aid and investment package for
Africa at the Forum on China-Africa Cooperation (FOCAC)
16 / CKGSB Knowledge 2018
in September, with some arguing the money should be invested
domestically. Will this influence policy?
A. My wife is from Beijing and normally does not pay attention
to foreign policy news, but she and her friends discussed this issue
when the $60 billion package was announced. I think there will be
more discussions like that and Beijing does have to be careful. But
they can get away with a lot because of the political system. And
of course, they will portray this as a way of making China great
again, as Xi Jinping has done with his talk of the ‘great rejuvenation
of the Chinese nation.’ I doubt there’ll be enough popular pressure
for them to dial back their grand plans overseas. But it may make
them think a little harder about the value of those investments, so
that they do not appear to be throwing money away.
Q. China’s Asian Dream predicted that China’s preference for
dealing with individual leaders could prove counterproductive.
Recent events in Malaysia and Pakistan support that. Are there
signs that China is changing its approach?
A. It does not seem to have changed. In fact, China doesn’t have
a lot of choice in some countries. If they’re dealing with either
authoritarian regimes or imperfect democracies, who else do they
go through? I think they will continue to deal with individuals at
the top, but they’re going to have to learn that it doesn’t pay to pay
off cronies of leaders. In democratic countries, it will come back
and slap you in the face.
Q. How do you see BRI developing over the next five years?
A. Xi Jinping is not going to step back from it. I think he made this
clear at the symposium marking the fifth anniversary of the BRI in
August. China may become more careful in how it lends money
and may try to be more sensitive to the financial burden it imposes
on other countries, but the policy is not going to change. I think we
will still be talking about it in five years’ time.
 Fall 2018

BETTING ALL THE CHIPS

The stakes are high as China seeks to build a world-class
semiconductors industry
By Matthew Fulco

Image by José Luna

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Economy & Policy

Beijing is doing
F
or China’s technology sector, the
decision of the United States to hit
everything it can Shenzhen-based telecommunications
giant ZTE with a trade ban in April was an
to reduce China’s abrupt and painful wake-up call.
Until then, many in China had grown
dependence on accustomed to thinking of their country
as a global leader in technology. After all,
foreign-made China’s smartphones, high-speed railways
and e-commerce platforms were the envy
microchips, which of the world. But in the days following the
ban, designed to punish ZTE for violating
the country now US sanctions on Iran and North Korea, it
became clear that one of China’s most
spends more successful companies was totally dependent
on American suppliers.
on importing ZTE’s business was crippled and it
announced it would have to shut down.
than crude oil. The firm, and the jobs of its 75,000
employees, was saved only by the Trump
But catching administration’s reversal of the ban in July.
The tech company’s most glaring
up with the weakness was reliance on American
microchips. Deprived of Snapdragon
world’s leading processors from San Diego-based
Qualcomm, the firm’s smartphones could
semiconductor not function. Overall, ZTE sources 53% of
its chips from the US, at a cost of more than
firms will not be $3 billion per year.
Virtually every major Chinese tech
easy firm is in a similar position. More than
90% of the integrated circuits (ICs) that
China uses are either imported or made
domestically by foreign chipmakers. In
2017, semiconductor product imports
totaled $260 billion, more than the country
spent on importing crude oil.
Leaders in Beijing see this chip
dependency as a national security threat,
especially in a time of heightened tensions
with the United States. Given the strategic
importance of the semiconductor industry,
they may be right to worry.
“You need semiconductors for
everything,” says Roger Sheng, a
semiconductor industry analyst at research
firm Gartner. “On every digital, connected
device, all information is transmitted on IC-
based infrastructure.”
In May, while ZTE’s future still hung in
the balance, Beijing called for the country to
redouble its efforts to achieve independence
in “core and key technologies.”
“The initiatives of innovation and
development must be securely kept in our
own hands,” said President Xi Jinping,
according to state newswire Xinhua.
Officials and CEOs scrambled to
answer Xi’s call. More than 10 local
governments set up their own chip industry
funds, and Beijing is set to announce a huge
$47 billion national fund later this year.
Major companies including Alibaba, Gree
Electric and Tencent have pledged to invest
more in IC research and development.
Flush with cash, China’s IC makers
are expanding rapidly. The country’s chip
industry revenues will grow 20% this year
to reach RMB 600 billion ($87.5 billion),
research firm TrendForce forecasts.
Chinese IC designers now hold 30% of the
global market.
But Chinese firms still lag far behind
top global firms such as Intel, Samsung and
Taiwan Semiconductor (TSMC) in terms
of technology. Domestic CPUs are only 30-
50% as efficient as those produced by Intel,
according to the Beijing Semiconductor
Industry Association.
“We still face big challenges in
producing reliable core components, and
many products are still mid-tier to low-
end,” said Xin Guobin, Vice-minister of
Industry and Information Technology,
in January. Catching up with the world’s
leading semiconductor firms will be a
daunting challenge for Chinese players and
doing so will require more than just money.
Taking Back Control
Though the ZTE case has led to a surge
of investment in semiconductors, China’s
attempts to build a domestic chip industry
go back much further. “The government
has worried about [IC] supply crunches for
a long time,” says Sheng.
Beijing first poured funding into the IC
industry following another external shock
from the US: the 2013 revelations by Edward
Snowden. The former National Security
Agency contractor made public that the US
government was conducting widespread
surveillance activities, including in China,
often with the compliance of American
hardware manufacturers.
“[After the Snowden leaks,] China

18 / CKGSB Knowledge 2018

 Fall 2018

Hungry for Chips China imports far more semiconductor products than any other country

China semiconductor market size Global semiconductor market share by consumption

Rest of the world Europe China
250
Japan Americas
100%
200
Market size ($ billion)

80%
150
60%
100
40%

50 20%

0 0%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: CCID, CSIA, PWC, ANZ Research

felt that dependence on US and Japanese chipmakers. In 2015, the Beijing-based military hardware or the ability of US
technology could compromise national company reportedly offered $23 billion technology companies to remain at the
security,” says Mario Morales, a senior for Micron, a US company that is a world forefront of the research and development
semiconductor industry researcher at leader in memory chip technology. curve,” says Ross Feingold, a Taipei-based
International Data Corporation (IDC) in After Micron’s executives rejected the political risk consultant and expert on US
California. offer, Unigroup turned to Taiwan, making foreign policy.
Beijing responded with a plan designed high-profile bids for three firms involved “Past and ongoing incidents of
to develop a competitive chip industry in in the lucrative IC packaging and testing intellectual property theft in the IC industry
record time, named the National Guidelines industry. But these deals also fell through give the Trump administration sufficient
for the Development and Promotion of the after the Chinese company encountered political capital to block transactions, even
IC Industry, in June 2014. The government pushback from Taiwan regulators. if the acquirers in the blocked transactions
backed this up by setting up a $22 billion These abortive moves appear to were not involved in any theft incidents.”
fund to invest in local chip firms. have done lasting damage to Chinese
Beijing’s strategy focused on acquiring companies’ ability to invest abroad. Long Road Ahead
foreign IC technology to help local firms Foreign governments are increasingly wary Blocked from external acquisitions,
catch up quickly. Officials encouraged the of approving deals in sensitive industries. China’s IC industry will be forced to take
creation of national champions that could “Unigroup has been too aggressive in its the slow road, but China has arrived late to
go out and buy prime overseas chipmakers. announcements,” says Sheng. the game. It took the United States, Japan,
The approach had initial successes, but also Under President Donald Trump, South Korea and Taiwan decades to build
led to a backlash that still hampers Chinese Washington has blocked big-ticket Chinese up world-class IC makers.
investment today. bids for US chipmakers including Lattice “You can’t build a semiconductor
Leading the charge was Tsinghua and Xterra. It has also prevented the sale sector overnight—the technology is too
Unigroup, a private-equity arm of the elite of Qualcomm to Broadcom amid concerns complex,” says Sheng.
Tsinghua University in Beijing. Sheng that the Singaporean company had close To be sure, China will attempt to speed
compares the firm to the Japanese telecom ties to Beijing. up this process by spending big. Bernstein
and tech investor SoftBank, but focused Trump has also handed the US Research forecasts that China’s spending
exclusively on IC investments. government greater powers to review and on IC fab equipment will double to $7.1
Between December 2013 and restrict foreign investments for national billion this year and reach $11 billion in
September 2014, Unigroup merged with security reasons, a move implicitly directed 2019. At least 11 local governments across
local IC maker Spreadtrum, acquired US- at China’s tech ambitions. This will likely the nation are aiming to set up production
based fabless semiconductor company make it even harder for Chinese IC firms to facilities: the cities of Beijing, Chengdu,
RDA and inked a strategic partnership with invest in the US in the future. Chongqing, Hefei, Shanghai, Shenzhen,
Intel. That deal gave the American IC giant “The primary concern of the Trump Wuhan, Xiamen and reportedly Liaoning
a 20% stake in the holding company that administration when blocking Chinese- and Shaanxi Provinces too.
owns Spreadtrum and RDA. linked companies from acquisitions of US But some local governments, lacking
Following these successes, Unigroup IC companies is to safeguard US national knowledge of the IC industry, may end
grew bolder and set its sights on top global security, whether assessed by risks to up building fabs to nowhere, according to

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Economy & Policy
MAKING PROGRESS China’s semiconductor firms have slowly but steadily increased their market share
Top Chinese mainland fabless suppliers by revenue
Company Background
Subsidiary of telecom $3.87
HiSilicon
giant Huawei
Tsinghua
Government-backed
group that acquired
Unigroup
Spreadtrum and RDA
Founded in California
Omnivision and sold to Chinese
investors in 2015
ZTE Subsidiary of leading
Microelectronics telecom firm ZTE
Subsidiary of central
CEC Huada government-
controlled enterprise
Main supplier
to government-
Nari Smart Chip
controlled utility firm million
State Grid
Source: IC Insights, Electronic Design
one industry insider. “There are too many
fab projects and not enough engineers to
support the factories,” says the insider, who
preferred not to give their name due to the
sensitivity of the topic. “Local officials are
just eager to show their support for a big
central-government initiative.”
Talent shortages will be an ongoing
problem for the IC industry. An August
report in the state-run Global Times noted
there are presently only about 400,000
of the 720,000 engineers needed for the
growing sector.
Chinese chipmakers are attempting
to overcome this by poaching engineers
from Taiwan, where salaries are lower and
workers share a common language with
their mainland colleagues. Around 1,300
engineers have crossed the Taiwan Strait
since 2014, and the brain drain is becoming
a concern for Taipei. However, this still
leaves an enormous number of vacancies
to fill.
The IC industry is also adversely
affected by the Sino-US trade war, as
Washington has imposed tariffs on billions
of dollars’ worth of semiconductor products
imported from China.
“For this reason, chipmakers will focus
mainly on the local market and therefore
it will somewhat slow and limit China’s
plans to grow the global influence of its
IC industry,” says Jane Yeh, an industry
20 / CKGSB Knowledge 2018
Fabless semiconductor industry market share by sales, 2017
Revenue
billion
17%
$1.86
1%
billion
2%
$1.39
billion
11%
$893
million
$506
16%
million
$478
analyst at the semi-governmental Market
Intelligence & Consulting Institute (MIC)
in Taipei.
Companies will likely continue efforts
to acquire foreign technology wherever
they can. South Korean media reported
last October that Tsinghua Unigroup had
approached Icheon-based chipmaker SK
Hynix about establishing a joint venture in
China. Reportedly, under the deal SK Hynix
would license flash memory technology to
Unigroup in a bid to bolster its presence in
the massive China market.
Both SK Hynix and Tsinghua Unigroup
have denied the reports. South Korean
IC makers are unlikely to share their
technology with Chinese counterparts,
Morales says. SK Hynix rebuffed a
previous overture from Unigroup in 2015.
Pressure is also being ramped up
on foreign companies doing business
in China. Foreign chipmakers complain
of attempts to steal their intellectual
property or force firms to sign patent-
licensing agreements with domestic IC
companies. Chinese regulators have also
launched antitrust investigations into
Micron, Samsung and SK Hynix, which
are accused of using their strong market
positions to hike prices, according to
Japan’s Nikkei Asian Review.
Global firms will continue to invest
in the mainland regardless, as China
US Taiwan
Chinese mainland Europe
Japan Other
53%
2010 market share
US 69%
Taiwan 17%
Chinese mainland 5%
Europe 4%
Japan 1%
Other 4%
accounts for 60% of global demand for
semiconductors, PwC estimates. But
foreign companies are paying even more
attention to information security in China.
According to the semiconductor industry
insider, one South Korean firm has become
so concerned about trade-secret leaks
that it has set up secure communications
between its China factories and its
headquarters.
The stakes are high for overseas players,
since they have built up a formidable lead
in IC research and development. Intel,
Samsung and TSMC already produce
10-nanometer chips and are working on
7-nm chips. China’s leading semiconductor
firms, meanwhile, have yet to move beyond
28-nm chips. There are no mainland
Chinese companies among the world’s top
10 chipmakers in terms of R&D spending,
according to research firm IC Insights.
US chipmakers, which make up half
of the top 10, will be particularly hard to
catch. The American players have acquired
many crucial microprocessor and graphics-
processor patents that have helped them
secure “a rather dominant share” of the
global IC market, observes Yeh. It will
not be easy for China to develop similar
technology independently.
“China’s goal of self-sufficiency in
semiconductor production appears to be a
distant dream,” concludes Yeh.
 Fall 2018

WHEN THE TAPS

RUN DRY
Water shortages threaten hundreds of cities across
northern China
By John Christian

An island temple stands on the dried-up bed of

Poyang Lake in southeast China

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Economy & Policy

Water flows from the Danjiangkou Reservoir into the Central Route of the South-North Water Transfer Project in Hubei Province

T
he moment finally came just after Lunar New Year, 2016. North Water Transfer Project. This vast network of canals, which
That morning, residents in Lintao, a city of 200,000 in the has already cost a staggering $62 billion, is designed to provide
remote northwest, turned on the taps, but no water flowed. relief to the parched capital, Beijing.
The groundwater that provided the town’s supply had simply run As Beijing’s population swelled to more than 20 million, the
out. city resorted to overusing groundwater to meet demand. Reserves
A year later, Si County, a cluster of settlements 2,000 are now being emptied so rapidly that the city is sinking more
kilometers to the southeast, also ran dry. After municipal than 11 centimeters every year as aquifers collapse, according to
wells began to empty, local schools satellite radar observations. The per capita
and hospitals resorted to drilling their water resources of the Beijing-Tianjin-
own. But even private wells are often Hebei region, home to some 112 million
ineffective as the county’s daily water people, are lower than the per capita annual
shortage has surpassed 20 million liters. consumption of Saudi Arabia, a country of
Hundreds of cities across China now In 1990, there were 32 million people which, unlike China, can
face similar crises as the country’s rapid 50,000 rivers in China. afford the energy resources to desalinate,
development takes a terrible toll on water according to Parton.
supplies. Urbanization and industrialization
Now, there are only The first phase of the project was
on a massive scale have led to an enormous 22,000 completed in 2014 and now delivers
rise in water use. billions of tons of water from the Yangtze
In the north, which contains nearly half River to Beijing. As a feat of engineering,
of the population but only 20% of the water resources, there is not it is impressive, but critics argue that the project will only provide
enough to meet demand. Groundwater storage on the North China temporary relief. The capital still has an annual shortfall of 400
Plain fell at a rate of more than 6 trillion liters a year between 2002 million cubic meters of water and continues to rely on pumping
and 2014. groundwater. The Economist, with trademark snark, labeled the
In 1990, there were 50,000 rivers in China. Now, there are canal system a “massive diversion.”
only 22,000. Even the mighty Yellow River, once called “China’s
Sorrow” due to the devastating floods it unleashed, is a shadow of South-North Water Transfer Project
its former self. Flow has fallen so much that the river often fails
to reach the sea. Yellow River
Beijing

Former Premier Wen Jiabao warned in 1999 that the growing Tianjin

water crisis could be a threat to the “survival of the Chinese Weihai

nation.” Many analysts agree.

“These problems are massive. You wouldn’t expect any Central Route
1,264 km
East Route
1,152 km
government to easily solve them,” says Charles Parton, a former Zhengzhou
British diplomat in China and Associate Fellow at the Royal West Route
United Services Institute (RUSI) think tank. 450 km
Yangzhou
Nanyang
Shanghai
er

Drastic Measures
Riv

Three Gorges Dam

tze

A large part of the government’s response so far has been to tackle

g
Yan

the problems with grandiose engineering projects like the South-

22 / CKGSB Knowledge 2018

 Fall 2018

Other proposed fixes appear more outlandish. Officials in

Gansu, the arid province where Lintao is located, have suggested Areas experiencing
transferring water 2,000 kilometers from Siberia. Other ideas water stress, 2015
include shipping vast quantities of snow across the country or
storing river water so that it is not “wasted” by flowing into the
ocean. Technology for a rain-seeding network that could one day
cover an area three times as large as Spain is currently being tested Lintao

in Tibet.
While these projects might bear fruit, a long-term solution
will need to tackle the skyrocketing demand for water, as well
as increase supply. Luckily, the government has already taken
many steps designed to do this, although these efforts have so far Si County
received little attention from the media.
“In the last five years, China has completely reframed how
it manages its environment,” says Debra Tan, Director of China
Water Risk, a Hong Kong-based nonprofit research organization. Baseline Water Stress
“This year, the government entrenched the concept of ‘ecological withdrawals/available flow
civilization’ in the constitution.” Low (<10%)
Like many phrases coined by the Chinese Communist Party, Low to medium (10-20%)
there is debate on the meaning of “ecological civilization,” but Medium to high (20-40%)
it is clear that it is more than just environmental protection. The High (40-80%)

approach seeks harmony between the economy, politics, society

and the natural world.
The constitutional tweak has also produced concrete results.
Tan points to the cutting of subsidies for cotton grown on the
North China Plain, an area stretching from Beijing to Nanjing that
is famed for its fertile soil. One-quarter of China’s cotton crop is
grown on the plain, and this has exacerbated the region’s water
issues. Growing cotton requires over five times the amount of
water per kilogram than cereals such as wheat.
Switching crops could save up to 8 billion cubic meters of
water, double the annual consumption of Beijing. There is huge
potential for savings across the economy, particularly in the
inefficient agriculture sector, which accounts for 63% of water
usage.
Nearly 50% of water used for irrigation, for example, is
wasted. This is primarily because flood irrigation, the oldest and
most commonly used method, simply dumps water on fields where
most of it evaporates or runs off. The country has been investing
in more modern methods, such as drip irrigation, which pipes
water directly to plants, and to good effect. Irrigation efficiency
rose from 0.44 in 2004 to 0.53 in 2016. This is still far below the
developed world average of 0.7-0.8, but progress nevertheless.
But Parton is doubtful whether further efficiency leaps will
be possible in the short term. “Low-hanging fruit can still be
expensive fruit,” he says.
According to Parton, the dominance of smallholder farms may
be a roadblock to investment. In 2013, 86% of Chinese farms were
1.6 acres or smaller. The government has been pushing corporate
farming, but this has been inhibited by sluggish land rights reform.
The efficiency problem is ultimately a political issue. “Until you
can allow larger-scale farming, who is going to pay for these
upgrades?” Parton asks.
Extremely high (>80%)
Arid & low water use
No data
Source: World Resources Institute
Taxing Problems
Another potential solution is to use the tax system to discourage
businesses and individuals from wasting water. Analysts have
long observed that water is so cheap in China that overexploitation
is almost inevitable. Until recently, water tariffs for businesses
were $1 per cubic meter, a third of the rate in the United States,
despite the US having more than triple the amount of renewable
fresh water per capita.
Hebei Province has trialed a water resources tax, and a
larger pilot project is underway involving nine further provinces.
But raising the cost of water could risk the economy and social
stability.
“Farmers, for example, are not used to paying for water,” says
Parton. “Farmers do not make a great deal of money, and so if
you start charging them a realistic price you will exacerbate their
problems.”
The new tax avoids this by adopting a more granular approach.
First, not all uses are taxed equally. Water for golf courses,
for example, will be taxed at a higher rate than for non-luxury
activities. Second, water extracted in areas experiencing high
water stress is taxed at a higher rate than areas where water is
plentiful.
These measures appear to be effective. Before the pilot, Hebei
used only 13.8% of its quota of water from the transfer project.
Since the scheme was introduced, 85% of water supply plants
have changed their source from groundwater to transferred water,
according to China Water Risk.
A separate pilot scheme is tackling water pollution—also

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Economy & Policy
an important contributor to water scarcity—by introducing a
cap-and-trade system that requires factories to buy permits to
discharge wastewater. In some areas, these permits now trade for
hundreds of times their face value and can be used as collateral for
loans. This encourages players unable to meet pollution standards
to close up shop.
But such reforms may not be enough. Some of the most water-
intensive industries, such as coal mining and power generation,
will always be based in the northern provinces, where the
resources are located. And most companies in these industries are
state-owned enterprises with severe financial difficulties, which
could ill-afford the extra costs of emission-saving technologies
and higher charges.
Perhaps the most important lesson of the local trials,
however, is that the water challenges are just that: local. China
is often presented as a country of two halves, but in hydrological
terms it is made up of over 1,100 separate catchments, or areas
of natural water collection. If the issues are viewed at this micro
level, problems that appeared imposing can suddenly seem
manageable.
Dr. Wang Jiao, an associate at the World Resources Institute’s
China Water Team, believes that there is reason for hope. Dr.
Wang’s team has evaluated the effectiveness of a 2012 policy
known as the “Three Red Lines,” which mandated stricter
management of water resources by capping total annual water
usage at 700 billion cubic meters by 2030, increasing irrigation
efficiency and protecting water quality.
“We found that the rate of increase in water withdrawals
slowed from 5.1 billion cubic meters per year in 2001-2010, to 1.6
The Yellow River is the most
CHINA’S SORROW threatened river in the region
Baseline water stress of major Asian rivers
Extremely high (>80%) High (40-80%) Medium to high (20-40%)
Low to medium (10-20%) Low (<10%)
0% 10% 20% 30% 40% 50% 60%
Yellow
Indus
Tarim
Ganges
Amu Darya
Yangtze
Mekong
Salween
Irrawaddy
Brahmaputra
Source: China Water Risk, World Resource Institute
24 / CKGSB Knowledge 2018
billion cubic meters per year in 2010-2015,” says Dr. Wang. The
team also observed that areas experiencing a decrease in water
stress grew ninefold during those same periods studied.
Dr. Wang cautions that this does not mean that China is close
to solving the problem, but it indicates that it is making progress.
“We consider these results to be positive,” she adds. “At least it’s
not getting worse.”
Man vs. Nature
If China is to reverse, rather than merely slow, water scarcity,
there needs to be buy-in across society. Fortunately, this is starting
to happen. Several sub-national governments are following
Beijing’s lead in setting up their own water management systems,
and these sometimes have even stricter policies. Regions are also
slowly starting to work together to find solutions.
“Some provinces are working on river policy more
collaboratively,” says Stephanie Jensen-Cormier, China
Program Consultant for the NGO International Rivers. “They
are looking at eco-compensation systems, which would provide
compensation for areas that chose not to develop their section
of a river.”
However, some observers feel that a truly sustainable
solution must involve a fundamental shift in how China, and
indeed humanity, views economic progress. Debra Tan, of China
Water Risk, calls this “water-nomics.”
“We have to look beyond things like efficiency savings,”
says Tan. “It is about wedding water resources management into
economic planning.”
Doing this effectively in China would result in big changes in
the global economy due to China’s leading position. According to
Tan, one easily understandable change will be the disappearance
of “fast fashion,” which relies on supply chains made possible
in significant part by the abuse of water resources. “China’s
manufacturing prowess led to the rise to fast fashion. So if China
now changes the rules of the game, it follows that that business
model will also change,” she says.
70% 80% 90% 100% Readjusting the entire economy is a tall order, but far from
impossible—China did it once already, under the leadership of
Deng Xiaoping. But the real curve ball is climate change. Nobody
is sure how severe the effects will be, but research suggests that
China will be hit hard.
One recent study by MIT found that that the North China
Plain could become prone to severe heatwaves that top a “wet-
bulb temperature” of 35 degrees (95 degrees Fahrenheit) by the
end of the century. At that level of heat and humidity, even fit
people sitting in the shade would die within six hours.
Such dire predictions have produced a growing chorus of
fatalists arguing that climate change is a done deal and none of
China’s efforts can prevent a crisis. But the only sure way to fail
is to give up.
“It is about what is most important at the moment, and what
is doable,” says Dr. Wang. “I believe if you do something, there
is a high chance things will get better.”
 Fall 2018

Trading Places
Despite a record trade surplus with the
United States, China could soon be running
a current account deficit. What would this
mean for the global economy?
By James Lord

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Economy & Policy
I
n early August, just as the United States was escalating its
trade war with China, the release of a surprising set of eco-
nomic data briefly threw the media debate off course.
Since February, attention had been focused on China’s $375
billion trade surplus with the US. President Donald Trump had
repeatedly pointed to the massive surplus as evidence that China
was a mercantilist power “ripping off” America.
But on August 6, China’s State Administration of Foreign
Exchange released figures that complicated this narrative. The
country’s current account, which is effectively determined by its
overall balance of trade in goods and services, dipped to a deficit of
$29 billion for the first half of 2018. Though China is still “ripping
off” the US, it is also now being ripped off by the rest of the world.
The move into deficit underlines the fact that China’s economy
is undergoing fundamental changes that will have impacts far
beyond its borders. A decade ago, China’s huge current account
surplus was the symbol of its status as the “factory of the world.”
The surplus surged following China’s entry into the World Trade
Organization in 2001, reaching a peak of 9.9% of gross domestic
product (GDP) in 2007.
But in recent years, that surplus has been steadily shrinking.
Last year, it sank to 1.3% of GDP. The half-year deficit announced
in August was the first in more than 20 years.
Seasonal factors mean that China may not post an annual
deficit this year, but some economists think that it is only a matter
of time before it does. Deutsche Bank predicts a Chinese deficit
by 2020.
If that happens, it will be a watershed moment with
implications for all manner of issues, from the policies Beijing is
able to pursue to the status of the RMB as a global currency and
maybe even the way the US finances its debt.
“When a country moves from a long era of surpluses to a
deficit, it’s a bit like a regime change,” says David Lubin, Head of
Emerging Markets at Citi. “The market has to go through a process
of developing a new understanding of how the economy works.”
When a country moves
from a long era of
surpluses to a deficit,
it’s a bit like a regime
change
David Lubin
Head of Emerging Markets
Citi
26 / CKGSB Knowledge 2018
THE END OF CHIMERICA
The US and Chinese economies are decoupling
Current account balance ($ billion)
400
200
China
0
-200
-400
United States
-600
-800
2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: OECD
Yet there is still uncertainty over how the trade balance will
develop over the next few years—not least because of the policies
being pursued by the White House.
Political Data
There are two very different schools of thought on how to interpret
China’s fall toward a current account deficit. Some economists,
including Zhang Jun, Dean of the School of Economics at Fudan
University in Shanghai, fit the decline into the broader story of
China’s development.
“The fundamental reason is the policy shift in China, which
some call the rebalancing of the Chinese economy,” says Zhang.
“From 2008, Chinese policy toward the macro-economy changed
a lot. The focus has been on raising the level of domestic aggregate
demand.”
Rising consumption will almost inevitably lead to higher
demand for imports, and an economy of China’s size would
normally be expected to start running a current account deficit
when it transitions to a consumption-led growth model, according
to Zhang.
There is plenty of evidence suggesting that this is happening.
The national savings rate has fallen over the past decade, though
it still remains high at 46% of GDP, and household consumption
is rising faster than GDP. Goods imports are increasing twice
as quickly as exports. Most importantly, there has been a surge
in overseas tourism, which has sent China’s services deficit
ballooning from $15 billion in 2011 to $265 billion last year.
“When you look at why the current account balance has fallen,
it’s because of tourism,” says Lubin. “It’s almost literally a one-
word explanation.” He adds that travel accounted for some 85% of
the net services deficit over the past five years.
According to this logic, a deficit is more or less inevitable in
the long run as China moves toward a new economic model. “The
 Fall 2018

Shanghai remains the key trade hub linking China with the rest of the world

paradigm shift has already happened,” affirms Zhang. a reasonable first order estimate is that a 1% rise in import tariffs
But some analysts argue that the growth model has actually would normally reduce imports by 1%. If the trade war were to
changed much less than the current account figures suggest. The escalate further, this could have a real impact on China’s overall
fall in the trade balance has been driven, at least in part, by more trade balance.
contingent factors. But things are unlikely to be so simple. First, the US’s demand
Brad Setser, a senior fellow at the US Council on Foreign for imports is rising due to the Trump administration’s tax cuts and
Relations, points out that China’s goods trade surplus, though the strong dollar. Second, the value of the RMB has experienced
falling, remains large at $421 billion. And a significant driver of the sharpest downturn in decades since the trade war began to
the decline has been rising global prices for China’s top two goods heat up in April. This will make China’s exports cheaper, partially
imports: crude oil and semiconductors. offsetting the impact of US tariffs. It will also make imports and
China’s spending on foreign oil rose 39% year-on-year to foreign trips more expensive for Chinese consumers.
$162 billion in 2017, while semiconductor imports rose 13.9% to The bigger issue, though, is whether the trade war causes
$259 billion. If prices for these products were to fall, the trade Beijing to stall, or even rethink, its long-term plan to transition to a
surplus could start expanding again. consumption-led economy. There are several reasons why Beijing
There are also questions over the services deficit, which may
be smaller than it appears. The huge leap in tourism imports
recorded in 2014 was primarily the result of a change in the way
NEW BALANCE
China calculates spending data. This switch in methodology may China’s tourism spending abroad may be overestimated
even have been intentional. Current account balance, adjusted for different method
“Let me put it this way. At the time, due to the fall in oil prices, of calculating tourism spending ($ billion)
China’s current account surplus was soaring,” says Setser. “The $b
timing was certainly convenient.” 500
Overall, Setser believes that China’s current account balance
400
is undervalued by between $50 billion and $120 billion. If that
300
estimate is correct, it would suggest that there has been a structural
200
shift in the Chinese economy, but it has been slower than official
100
data implies. By extension, China could still be years from running
a “real” current account deficit. 0
When exactly the moment comes will also depend on how -100
Beijing deals with the largest economic challenge it has faced -200
since the crash of 2008: a trade war with the United States. -300
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
15
16
17
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20

Current Account Tourism Goods

Stick or Twist Adjusted Current Account Adjusted Tourism
On the surface, you would expect a tariff war with China’s largest
Source: China Customs, Haver Analytics, Brad Setser
export market to push down the trade balance. As Setser explains,

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Economy & Policy

may feel a return to the high-export, high-investment model is

necessary, at least temporarily. One is simply to shore up growth,
since the government appears to have little faith in consumption as
a driver of the economy.
“A lot of Chinese growth when you look at GDP is generated
by consumer spending, but the swings in economic activity appear
to be still related to infrastructure investment,” explains Lubin
of Citi. “There’s been a slowdown in 2018, and now the State
Council has turned the taps back on.”
In August, there was a marked acceleration in the number of
urban rail projects approved by the National Development and
Reform Commission. The Ministry of Finance also ordered local
governments to issue around RMB 1 trillion ($150 billion) worth
of special bonds, used to finance infrastructure and new housing
construction, within a two-month deadline.
Lubin also suspects that Beijing will be uneasy about running
a current account deficit during a time of heightened tension with
the US.
“The point about running a current account surplus for China
is that it means they’re not dependent on foreign capital to finance
their growth model, and so they have a high degree of autonomy,”
says Lubin.
“The prospect of a current account deficit for China gives,
in Beijing’s mind, the US some kind of strategic leverage over Investor confidence has fallen in China. Green indicates
China.” a stock is falling
This is even more the case since any liabilities China
would accumulate by running a deficit would likely be dollar- hard to imagine that China could do this after so many years and
denominated. Beijing’s efforts to internationalize the RMB have all the changes that have taken place.”
taken a “substantial backward step” since 2015, Lubin notes. There are fundamental demographic pressures pushing up
But abandoning the transition to a consumption-led economy wages in China, and so the export-led model appears unsustainable
would be extremely costly for China, as Zhang of Fudan University in the long term. A signal that China was moving back in this
emphasizes. direction would not only be unpopular politically but could also
“It’s really hard to reverse course,” says Zhang. “That would trigger a critical loss of investor confidence.
mean lowering the costs of manufacturing production, lowering The central bank’s struggle to manage the exchange rate
wage growth for workers and keeping the currency cheaper. It’s offers a sense of the dilemma facing China’s policymakers. While
a depreciation may help China deal with the impact of the trade
war, letting the rate fall too far could lead to panic in the financial
For large economies, markets.
“If the RMB rises to over seven against the dollar, I think that’s
a trade deficit has kind of an emotional threshold for investors,” says Zhang. In late
July, the Politburo appeared to make keeping the rate under RMB
historically been a 7 to the dollar official policy, proposing a “six stabilizations”
approach.
positive signal of an There is also the question of how much China can continue to
ramp up exports. “Global growth will not support Chinese export
economy’s health growth in the way that it has in the past, particularly if the US
tries to close down Chinese export growth,” predicts Lubin. In this
context, domestic demand may be the only sustainable driver of
Zhang Jun long-term growth.
Professor of Economics Given these pressures, Beijing appears to be in a bind. To push
forward with reforms in the current environment will be painful,
Fudan University but turning back will be even more so. Sooner or later, China will
need to forge ahead, and this will move it inexorably toward a

28 / CKGSB Knowledge 2018

 Fall 2018

A sign of things to come? China held its first ever import fair, the China International Import Expo, in November

the BRI, China’s Asian Dream, Tom Miller explains that one of the
RMB REVERSE reasons China launched the scheme was that it was looking for a
The exchange rate has plummeted in 2018 more profitable investment channel for its large reserves. Offering
RMB/USD exchange rate
commercial loans to finance foreign infrastructure projects had
the potential to produce higher returns than US Treasurys. Now,
0.170 some analysts argue that if the reserves start to dwindle, China
may become less willing to throw money at high-risk projects.
0.160 Yet a current account deficit may help China increase its
influence in other ways. For example, it could help China in its
0.150 efforts finally to make the RMB a global currency. “If you want to
export your money to the rest of the world, you have to import a
large share of global production,” says Zhang. “You have to be a
0.140
country with a large trade deficit.”
In many ways, Zhang argues, this could be a positive force,
0.130
2014 2015 2016 2017 2018
both for China and the global economy. “If China ran a trade
deficit then it would contribute a lot more to global growth,” he
says. “A trade deficit in the long run would not create a negative
Source: XE.com
image of the Chinese economy. For large economies, a deficit has
current account deficit. historically been a positive signal of an economy’s health.”
But to reap these benefits, China will need to complete its
Dealing with the Deficit long-awaited transition to a new economic model. This journey is
When China finally moves into a deficit, it will open up new risks, not going to be an easy one.
but also new opportunities. On the downside, the surplus has acted “The question of whether consumption continues to increase
as a useful safety net for Beijing in the past. When the economy is largely a political one, and the answer depends on to what extent
experienced capital flight in 2015 and 2016, China’s central bank the government is able to reform the system to allow a transition
drew on its enormous foreign exchange reserves to stabilize the away from investment policy,” says Maximilian Kärnfelt, an
market, spending around $1 trillion to prop up the exchange rate. economic analyst at the Mercator Institute for China Studies
If China is no longer able to use this kind of tool, the exchange rate (MERICS).
will become more volatile. The most difficult obstacles still lie ahead, and Beijing will
A depletion of China’s forex reserves could also have need to negotiate them without the safety harness of a bulging
implications for the Belt and Road Initiative (BRI). In his book on surplus.

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Snapshot

Breaking Down the

Current Account
Why China is moving from a record surplus to a current
account deficit
Until recently, China was an export-driven economy. The current account balance rose and fell
broadly in line with demand from global markets. But as China’s economy develops, these two
figures are decoupling.

Global recession Global recovery Global growth

hits; Chinese accelerates; surges; but fall
trade balance trade balance in trade balance
plummets rises continues

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Current account balance/GDP (%)

1000 10
Balance ($ billion)

500 5

0 0

-500 -5

Trade balance (goods) Trade balance (services) Current account balance

A Rebalancing Economy?
Beijing points to falling savings rates and rising consumption to explain the fall in the current account
balance. But some analysts argue that the rebalancing is relatively minor.

China gross savings rate (%) China final consumption expenditure (RMB billion)

52 50k
51 45k
40k
50 35k
49 30k
48 25k
20k
47 15k
46 10k
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Source: CEIC, Standard Chartered Research

30 / CKGSB Knowledge 2018

 Fall 2018

Rising Services Deficit

China’s deficit in services has ballooned in recent years due to the increasing number of Chinese
citizens traveling overseas. But some believe tourism spending is overestimated.

Services trade balance by type, 2017 ($ million) China travel service imports ($ billion)

300 China changes method of calculating

Travel tourism spending (see page 27)

250
Transport

Intellectual property charges 200

Construction
150
Maintenance services
100
Information technology services

50
Other

0
-250000 -200000 -150000 -100000 -50000 0 50000 2013 2014 2015 2016 2017

Falling Trade Surplus

China’s exports are still rising, and so are the country’s bilateral trade surpluses with several countries,
most notably the United States. But imports are rising twice as quickly, driven mainly by rising fuel
and semiconductor prices.

China total imports and exports, 2011-2017

SURGING IMPORTS
2500
Crude oil
2000 $162 billion (é 39%)
Total value ($ billion)

Petroleum gas
1500
Imports $33 billion (é 44%)
Exports
1000
Coal
$18.5 billion (é 60%)
500
Semiconductors
0 $259 billion (é 13.5%)
2011 2012 2013 2014 2015 2016 2017

Source: International Trade Centre, MOFCOM, Statista

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Economy & Policy
Has the West Lost It?
The West needs to radically rethink its strategic goals for the Asian century, argues
Kishore Mahbubani, Senior Advisor and Professor in the Practice of Public Policy
at the National University of Singapore
By Dominic Morgan
F
ew thinkers can speak about global governance with as much
authority as Kishore Mahbubani. A former President of
the United Nations Security Council, Permanent Secretary
of Singapore’s Foreign Ministry and Dean of the renowned Lee
Kuan Yew School of Public Policy at the National
University of Singapore, he has been named “the
muse of the Asian century” and listed among the
top 100 most influential public intellectuals in the
world by the Financial Times, Foreign Policy and
Prospect.
In his latest book, due next year, Mahbubani
plans to tackle the rising tensions between the
United States and China, and the former diplomat
has some frank advice for the West. As he explains,
the election of President Donald Trump and the
launching of a trade war with China should be
viewed as symptoms of the refusal of the US to
accept its inevitable decline as the world’s number
one economy. Instead of howling at the moon, the
US should embrace a more minimalist and strategic approach
to foreign policy to maximize its interests in an era of Asian
dominance.
Q: In your last book, Has the West Lost It?, you point out that
there has been a remarkable improvement in the quality of life
of people across the world over the past 30 years, but public
discourse in the West has become increasingly pessimistic. What
is behind this contradiction?
A: The great paradox, as I emphasize in the book, is that the dramatic
improvement in the human condition is the result of the generous
32 / CKGSB Knowledge 2018
gifts of the West to the rest, especially the gift of reasoning. And,
frankly, future historians looking back at our time would say that
the 30 years from roughly 1980 to 2010 saw probably the most
dramatic improvement in living standards in human history. So,
this should be a moment of great celebration in the
West—the great Western project of improving the
human condition has succeeded.
Paradoxically, the West has never been more
depressed. I think the one reason for this is that the
West made a huge strategic mistake at the end of
the Cold War in 1989: it was seduced by the essay
of Francis Fukuyama, “The End of History?,”
which basically said that the West had defeated the
Soviet Union and it could just switch on autopilot,
whereas the rest of the world needed to make
strategic adjustments to this new world.
Fukuyama’s essay did a lot of brain damage
to the West. He put the West to sleep precisely at
the moment when China and India were waking
up. For 1,800 of the past 2,000 years, the world’s two largest
economies have always been those two countries. The last 200
years have been a major historical aberration. And, of course, all
aberrations eventually come to a natural end.
But what no one could have foreseen in 1989 was the speed
at which China and India have re-emerged. In 1980, in purchasing
power parity terms, the United States’ share of global GDP (gross
domestic product) was 21.7% and China’s share was 2.3%, which
means that China’s share was around 10% of the US. By 2014,
astonishingly, China’s share had become bigger. That’s why it’s
such a dramatic period in human history.
 Fall 2018

Q: You outlined two key factors that have destabilized the West:
first, a decline in real wages following the entry of China and
Eastern Europe into the global trading system; and second a
realization that national governments are becoming powerless
to control the forces of globalization. Which of these is the most
The most
important?
A: They’re both related. I think just as the West made a big strategic
important
mistake at the end of the Cold War, another strategic mistake was
made in 2001 when 9/11 happened. I was actually in Manhattan strategic event
on 9/11, so I understood the shock that was felt by America. What
happened as a result of 9/11 was that America decided its biggest
strategic challenge was going to come from the Islamic world, so
that happened
it launched wars in Afghanistan and Iraq.
That was a mistake because the most important strategic
in 2001 was not
event that happened in 2001 was not 9/11 but China’s admission
into the World Trade Organization. China’s entry injected 800 9/11 but China’s
million workers into the global capitalist system and—as Joseph
Schumpeter taught us—that would lead to creative destruction.
So, it’s not surprising that in the decade that followed, lots of
admission into
people in the US and Europe lost their jobs. But because the elites
were benefiting from the expansion of the global economy, they
the World Trade
didn’t notice that their own masses were suffering.
So, I would say that future historians will see that the election Organization
of Donald Trump in 2016 was not a surprise, but an inevitable
result of the elites not taking care of their masses. The median
income of the American worker had not improved for 40 years.
That’s shocking. Everything is tied together to China’s admission becoming number two, subconsciously they must realize that
to the WTO. America is moving toward that status. Instead of looking in the
mirror and asking what mistakes you have made, it’s always easier
Q: Recently, many commentators in the US have been debating to find a scapegoat, and China is the obvious one. The danger is
whether it was a “mistake” to allow China to join the World that when you look for a scapegoat, you ignore the core structural
Trade Organization in 2001. What is your view on this debate? issues that America has to deal with in this new era.
A: There’s a wonderful Western expression, ‘there’s no point
shutting the door after the horse has bolted.’ This is a classic Q: How receptive should China be to the US’s complaints about
demonstration of that saying. China has already joined the WTO; its economic and trade practices?
it is part of the global trading system and is incredibly integrated A: I think the Chinese should figure out which complaints are
into it. There is nothing you can do about that. valid, and which are invalid. The invalid one is that the bilateral
What the West, and especially the US, needs to do is to adjust deficit is the result of the Chinese playing unfair—that is not
to this new competitive global system. I think it can adjust and can true at all. In fact, the trade deficit paradoxically helps American
do well, but it is a question of working with rather than against workers in some ways. Even though their income has not gone
China, which is why the current trade war is misguided. In fact, up, they can buy more things, more cheaply thanks to Made-in-
any sensible Western economist will tell you that America’s trade China products.
deficit is not a result of China playing unfairly. It is actually the But, of course, there are also valid complaints. First, China
result of the US having the global reserve currency, which allows may have been stealing intellectual property from American firms.
it to consume more than it produces. That is actually a privilege. Second, China has insisted that if American firms invest in China,
they are to transfer technology to China. Third, there are non-tariff
Q: In a recent article for Project Syndicate, you said you were barriers. China has lowered its tariff barriers and fulfilled its WTO
struck during a recent sabbatical in the US by how decisively obligations, but there are non-tariff barriers that have hindered
sentiment among the US elite has turned against China. What Western exports to China.
has caused this change? I think what China needs to do is respond with a certain
A: I don’t know, it’s mystifying, but it has happened. I think generosity of spirit, because China has done very well thanks to
there is a growing awareness that China is becoming bigger and the West opening up its markets. Now, China can reciprocate by
stronger. Even though Americans don’t like talking about America opening up its markets even more. That would also give the US

CKGSB Knowledge 2018

/ 33
Economy & Policy
The last two
centuries
of Western
dominance have
been a historical
aberration
and Europe a greater strategic interest in maintaining good ties
with China.
Q: The US is increasingly focusing its ire on China’s Made in
China 2025 strategy. What is your view on this strategy?
A: I think it’s legitimate for China to aspire to become a
technological superpower in its own right. Frankly, I think that
China is going to succeed. The US should not complain about
what China is doing, and instead ask itself what the American
response should be. But here, the ideology of people like US
Trade Representative Robert Lighthizer—who believes that all
government-led industrial policies don’t work—gets in the way.
If industrial policies don’t work, then why not allow this one
to fail? If you complain about it, that suggests you believe it’s
going to work. Now, if it’s going to work in China, why doesn’t
the United States launch its own comprehensive national strategy
to maintain its technological lead? Instead of complaining about
Made in China 2025, they should have a Made in America 2025.
Q: If China does emerge as the world’s leading economy, how
do you expect China to reshape the global order?
A: Just as America is reluctant to face the prospect of China
overtaking them, I think the Chinese are reluctant to face the
prospect of becoming number one. The Chinese should think
more about this, because it’s very important that China makes a
big effort to reassure the world that they’re going to maintain the
current rules-based order that the West has given the world. This
is essentially what Xi Jinping promised in his two speeches in
Geneva and Davos in January last year. And that’s the message
that needs to be repeated by China to the world.
It would be wise for China to strengthen the WTO, the
United Nations, the International Monetary Fund and the World
Bank, but that will require that the West gives up control.
34 / CKGSB Knowledge 2018
There was a rule created over 50 years ago that said the head
of the International Monetary Fund should always be European
and the World Bank leader should always be American. That
rule was credible when the West’s share of global GDP was
overwhelming, but when your relative share of the global
economy declines, and the most dynamic economies are in
Asia, why are you disqualifying Asians from running these two
organizations?
Q: How should the US and Europe position themselves in a
global system dominated by Asia?
A: Europe and the US need to face the fact that the last two
centuries of Western dominance have been a historical aberration,
and that aberration is coming to a natural end. They need to be
ready to deal with a world in which they remain strong, but in
which their relative share of global GDP has gone down. If your
share of GDP goes down, you need to adopt a new strategic
approach, and what I suggest in Has the West Lost it? is a new
“three-m” strategy for the West.
•T  he first is “minimalist.” The West should ask itself: should
it get involved in so many wars? Should it be intervening
in Afghanistan, Iraq, Libya, Syria, Yemen and so on? The
Chinese haven’t fired a shot in 40 years, since the end of the
war with Vietnam in 1979, whereas even during the last year
of the presidency of Barack Obama, a peaceful man who won
the Nobel Peace Prize, America dropped 26,000 bombs on
seven countries. That’s crazy.
•T  he second “m” is multilateral. Here, I build on the advice of
former President Bill Clinton, who told his fellow Americans
that if you can conceive of a world in which America is number
two, then surely it is in America’s interests to strengthen the
world’s multilateral order, which will then constrain the next
number one, China. The tragedy is that although the world’s
multilateral institutions are the West’s gift to the world, it is
America with the silent collusion of Europe that has been
weakening them. That’s unwise.
• And the third “m” is Machiavellian, which is just short for “be
pragmatic.” You want to focus on your own priorities and do
what’s important for you. So, for example, Europe’s long-
term challenge is not going to come from Russia—Russian
tanks are not going to invade Germany. But what you’re
going to get is a demographic explosion in Africa that’s going
to be a challenge. You’re going to get more refugees coming,
and we’ve seen what has happened to Europe politically
because of refugees. Therefore, it is in Europe’s interests to
see Africa develop, and the best partner to develop Africa is
China. America is frightened of China’s influence in Africa
and condemns Chinese investment there, and the Europeans,
because they’re subservient to America, also criticize China.
But China’s long-term strategic investment in Africa is a gift
to Europe. That’s what I mean about thinking in Machiavellian
terms about where your interests lie.
 Fall 2018

Robots sort packages at a distribution

center operated by ZTO Express in
partnership with Alibaba’s logistics arm
Cainiao

DELIVERING
THE FUTURE
How China’s e-commerce industry is pushing automation
to the next level
By Dominic Morgan

CKGSB Knowledge 2018

/ 35
A drone operated by Alibaba logistics arm Cainiao delivers tea leaves in the fields near Hangzhou
I
n a cavernous warehouse on the outskirts
of Kunshan, an industrial city in eastern
China, the stacks appear to be organizing
themselves. Several box-laden towers
trundle toward a packing area by the
entrance, while others, emptied of their
loads, glide silently back to their starting
positions.
The shelves are being marshaled by
a fleet of squat robots manufactured by
the Beijing-based startup Geek+. These
Roomba-like devices are capable of
crawling underneath and lifting stacks
weighing up to 500 kilograms, and then
transporting them wherever they are
needed.
Geek+ has a team of 120 of the robots—
also called automated guided vehicles,
or AGVs—working in the warehouse. It
operates them on behalf of up-and-coming
social commerce startup Yunji.
The AGVs enable the warehouse to
process up to 100,000 orders a day with
a staff of 20 human workers, work that
previously would have required 300-600
people, according to Geek+. The project
is part of a huge automation drive taking
place in China’s sprawling e-commerce
supply chain.
Unlike other sectors, leading online
36 / CKGSB Knowledge 2018
retailers like Alibaba and JD.com have
embraced automation enthusiastically. In
some areas, they are now ahead even of
Amazon.
China accounts for nearly half of global
demand for AGVs, and leading domestic
robot makers like Geek+ have emerged
as formidable global competitors. Alibaba
and JD.com have also announced plans to
invest billions of dollars to roll out next-
generation technologies including totally
unmanned warehouses and last-mile
delivery robots and drones.
People Problems
E-commerce firms, as well as the express
delivery firms they work with, such as
SF Express and ZTO Express, have been
forced to adapt to rapid demographic
changes. China’s working-age population
began to decline in 2013, and the pressure
on companies has been increasing ever
since.
“China is losing young people
quickly and labor costs are increasing
tremendously,” says Lian Jye Su, a robotics
industry researcher at ABI Research.
The e-commerce industry felt the
effects of these changes earlier than others
due to the massive growth in the online
retail market. Sales increased 32% year-on-
year in 2017 to reach $1.1 trillion, making
China’s e-commerce market more than
double the size of that of the US.
“You can use money to solve the labor
costs issue, but for our clients the bigger
challenge is that at peak times you just can’t
find enough people to get the job done,”
says Zheng Yong, CEO of Geek+.
Alibaba and JD.com started integrating
labor-saving technologies into their
warehouses in 2014, just two years after
Amazon acquired robot maker Kiva
Systems for $775 million. The decision
kick-started a frenzy in the automation
solutions market.
By 2016, sales of AGVs in China
reached 9,950 units, accounting for 44% of
the global total, and were growing 88% per
year. The technology was among the first
solutions to be implemented because it is
easy to introduce to modern warehouses
and increases efficiency dramatically.
Nearly every major warehouse run
by China’s leading e-commerce and
express players now integrates automation
technology, according to Julius Shen,
a consulting partner at PwC. Firms are
also introducing a much broader range of
solutions.

In the major cities, rising land costs
are pushing firms to create tri-dimensional
warehouses. These facilities, whose stacks
often stretch several stories high, require
automated picking, packing and sorting
solutions to manage their massive volumes
of goods.
“It’s becoming very difficult to
maintain a traditional warehouse in a city
like Shanghai,” says Shen. “The only way
to expand the capacity is to build upward.”
Automating package sorting is
particularly crucial for the major players
as they look to cope with a skyrocketing
number of orders while also cutting waiting
times for customers. China’s express
industry delivered more than 40 billion
packages in 2017, around half of total
deliveries worldwide, and this is likely to
hit 60 billion by 2020, PwC estimates.
In many modern facilities, sorting is
now handled by dozens of scurrying robots,
which dump individual packages down
different chutes based on their intended
destination.
“Nearly every e-commerce company
uses bar codes or QR (Quick Response)
codes for tracing, and so using automatic
sorting systems not only reduces labor costs
but also lowers the number of mistakes,”
explains Shen.
Robot Wars
At first, the major beneficiaries of this
boom in Chinese demand were the major
foreign automation solutions providers,
such as Japan-based industrial robotics firm
BUILDING BOOM E-commerce is driving demand for quality warehouse space in China
E-commerce market size ($ billion) Modern warehouse space per capita (sq m) China total warehouse capacity (million sq m)
China US
1800 3 70
1600
2.5
1400
1200 2
1000
1.5
800
600 1
400
0.5
200
0 0
2018 2022*
Source: Forrester, Statistia, JLL
FANUC. But Chinese startups like Geek+
have rapidly gained ground.
Hundreds of automation-related
startups have emerged in recent years
thanks in part to strong support from
Beijing, which wants China to become a
world leader in robotics by 2025. Beijing
has often been criticized for subsidizing
robotics startups that remain far behind
the leading firms from Europe, Japan and
the United States in terms of cutting-edge
technology. But in the logistics sector, the
barrier to entry is not so high, which handed
local players an opening.
“For industrial robots, it requires
precision and there is little room for trial and
error, whereas with solutions like AGVs
people are more open to experimenting and
introducing small innovations,” says Su, of
ABI Research.
Chinese robot makers gained an edge
by focusing on understanding their clients’
needs.
“The local players are humble and
willing to really dive into their specific
industries,” says PwC’s Shen. “They
understand the entire operations process
and have designed their products to be
100% customized not only for a single
industry, but even for different types of
companies within that industry.”
Zheng and his co-founders followed this
approach when they set up Geek+ in 2015.
“Relatively speaking, AGVs are not the
most advanced technology,” says Zheng.
“But we formed an innovative system to
solve real problems for our customers.”
China US
60
50
40
30
20
10
0
China US
Fall 2018
Geek+ thrived by offering clients a
level of service that companies based
overseas could not match, Zheng explained
in a recent interview.
“At Alibaba, they set up tents in
their offices in the month leading up to
the ‘Double-11’ e-commerce shopping
festival,” Zheng said. “So do our colleagues.
Our workers have to go to the warehouses
in the suburbs and stay there overnight to
guarantee the system operates stably.”
The sheer size of China’s e-commerce
market also offers firms like Geek+ a unique
advantage in terms of gaining know-how
and honing their products. In less than four
years, the company has shipped more than
3,000 robots, making it the leading provider
in China.
“We have accumulated a lot of
experience with different clients,” Zheng
says. “That level of shipments and on-the-
ground experience is unheard of in other
countries.”
These advantages have enabled domestic
firms to dominate the Chinese AGV
market, where local companies now have
an 85% market share, according to market
researchers Research in China. Geek+ now
considers its products to be more advanced
than any others on the market, including in
Europe and North America.
This is not an empty claim, says
Su of ABI Research. “Geek+ can offer
comparable technology at a lower price
[to their Western competitors] due to the
tremendous economies of scale offered by
China.”
China
2011 2012 2013 2014 2015 2016 2017 2018* 2019* 2020*
CKGSB Knowledge 2018
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Business Trends
Chinese companies are now investing
a lot more in autonomous mobile
robot technology. They are not very
far behind [the Western firms]—it’s a
matter of scale and time to market
The Chinese firm will soon put this to
the test. It set up its first overseas office in
Japan last year, and its warehouse robots
have received the CE Mark approval for
sale in the European Union.
Spreading the Revolution
Whether Geek+ will replicate its success
abroad remains unclear, but the way
domestic firms have caught up and
overtaken their competitors in the local
AGV market could be a harbinger of
things to come.
Nevertheless, there are still huge
growth opportunities for automation in
China. Even in the e-commerce industry,
one of the earliest adopters, only new-
build warehouses run by leading firms tend
to use new technologies. In the logistics
sector as a whole, the penetration ratio for
automation technology is around 20-30%,
whereas the average in most Western
countries is 70-80%, according to Shen.
However, most of the untapped
opportunities in e-commerce are with
smaller firms and local distribution
centers that foreign companies will find
hard to reach. The fact that most of the
low-hanging fruit have now gone is one
reason why Geek+ is looking to expand
internationally, Su notes.
Integrating new technologies is more
38 / CKGSB Knowledge 2018
Lian Jye Su
Robotics Industry Analyst
ABI Research
challenging in smaller facilities since the
solutions function in closer proximity to
staff. This could, in theory, favor foreign
companies. North American firms, for
example, are the leaders in manufacturing
autonomous mobile robots (AMRs), more
sophisticated robots than AGVs with
greater spatial awareness that are easier to
introduce to brownfield sites.
But domestic AGV makers are closing
this gap. “Chinese companies are now
investing a lot more in AMR technology,”
says Su. “They are not very far behind—
it’s a matter of scale and time to market.”
Other opportunities are opening as
the leading e-commerce players ramp
up investment in logistics. Per capita
warehouse space is still far lower than in
the US and will expand by 20% per year for
the next several years, according to Shen.
Firms are also experimenting with
completely unmanned warehouses, a
major technological undertaking that
requires a complex system of synchronized
solutions. JD.com opened its first such
facility on a trial basis earlier this year,
and Geek+ aims to follow suit before the
end of 2018.
JD.com has also been operating drone
delivery services to rural areas for 18
months, and raised $2.5 billion through
a stock sale in February to invest in last-
mile delivery and other logistics solutions.
Alibaba, meanwhile, has pledged to invest
$15 billion to build a logistics network
capable of delivering packages anywhere
in China within 24 hours and globally in
72 hours.
But Shen expects that, even in the
most cutting-edge areas, foreign providers
will come under increasing pressure. “We
expect import substitution to be a trend in
China’s e-commerce industry.
“The market share of foreign
automation solution providers is still
relatively high in e-commerce, but we
believe local players will increasingly
penetrate into these areas.”
Up to now, domestic firms have mainly
been small-scale and offered highly
specialized solutions for very specific
markets. But this is changing as the
automation solutions market consolidates
and firms look to expand into new areas.
Geek+ has already developed moving
and sorting robots in addition to its
AGVs, which will allow it to move into
manufacturing. Like many firms, it also
aims to broaden its logistics client base
from e-commerce into a number of less-
automated industries.
“We are targeting all retailers,” says
Zheng. “That includes brick-and-mortar
retailers, pharmaceutical companies or
makers of fast-moving consumer goods,
shoes or apparel. As long as it is retail-
related, our products can be used.”
As a new generation of larger Chinese
automation companies offering a broad
range of solutions emerges, they may even
pose a threat to global rivals in their home
markets.
Will the warehouses of the future be
run by robots designed in Beijing? It is
possible, especially when you consider
that it has taken the Chinese players less
than five years to get where they are now.
But, for Shen, the unique conditions that
made this revolution possible may also
prevent it spreading further.
“If we are talking specifically about
e-commerce, China is already the world’s
largest market, but it’s unique,” he says.
“It’s not easy for these companies to adapt
to new markets when they go overseas.”

In the Express Lane
Eddy Chan, President of FedEx China, explains how the Belt and Road Initiative is
changing the global logistics market
E
conomic changes taking place in China are rippling across
the world, causing rapid upheaval in global supply chains.
Manufacturers are moving to lower-wage economies, the
Belt and Road Initiative (BRI) is creating a new web of trade flows
and the rise of cross-border e-commerce is accelerating demand
for goods from across the world. And then, of
course, there is a possible global trade war to factor
into the equation.
Dealing with all this uncertainty requires ice-
cool pragmatism, as FedEx’s China head, Eddy
Chan, has learned. The Hong Kong native has
worked at FedEx for most of the past 30 years, and
he believes that the key to success is focusing on
the firm’s three main dictums: think global, listen
to your customers and always be one step ahead.
In this interview, he explains how he plans to apply
that philosophy in an era of unprecedented change
for his industry.
Q. FedEx entered the mainland China market in
1984. How have your operations here evolved since then?
A. Our operations have gone through several phases. When we
entered the market, most multinational companies were just
setting up a representative office in China and doing research. Our
customers needed inbound express services, so we focused on that.
Later, we spotted that China was set to become the factory of
the world. So, in the mid-1990s, we became the first international
express company to set up our own freight aircraft service in China.
We were also the first to introduce electronic data interchange
(EDI) connections, which allowed us to gain expedited customs
clearance.
From 2007, when we bought back our shares from our joint
venture partner and became a wholly foreign-owned enterprise,
we noticed that China was becoming the center of the global
supply chain. So, two years later we became the first global
Fall 2018
express company to set up our Asia-Pacific hub in Guangzhou.
In 2007, we also became the first foreign firm to enter China’s
domestic express market.
As time went by, we have also seen Shanghai become China’s
window to the world—it has the number one ocean terminal in the
world, and the third largest airport in terms of cargo
handling after Hong Kong and Memphis, where
FedEx’s headquarters is located. So, this year we
set up our international express and cargo hub in
Shanghai.
Q. How large is FedEx’s presence in China’s
logistics and delivery market today?
A. FedEx provides a comprehensive service to
customers in China with international express
and domestic express services and we also, as a
cargo airline, provide space to freight forwarding
companies. After the integration with TNT, a
European company that we acquired in 2015,
FedEx has 12,000 employees. On a weekly basis,
FedEx operates around 250 flights into and out of China and we
have over 3,300 vehicles.
Q. To what extent does FedEx see itself as competing with the
major domestic express firms?
A. We welcome competition, no matter if it is from local
companies or international companies. That’s because we
believe that competition is a good way to cultivate a healthy
market and that customers and industry players can benefit. But
for this competition to work, there needs to be a level playing
field.
I’m glad to say that the overall competitive environment in
China is developing healthily, governments are in general treating
us [express firms] more or less the same. We are not asking for
preferential treatment. What we’re asking for is fair competition.
CKGSB Knowledge 2018
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Business Trends
FedEx Freight is
using blockchain
technology to
share shipment
information among
suppliers, FedEx
and retailers
Q. FedEx Express has said it expects the Belt and Road Initiative
to boost demand for its services. What opportunities is the BRI
opening up for you?
A. We think that the Belt and Road Initiative is crucial for global
supply chains. The value of China’s imports and exports to and
from the Belt and Road countries reached RMB 7.4 trillion ($1.05
trillion) in 2017, up 17.8% year-on-year. We have made some
strategic decisions because of this.
First, we recently acquired some companies in Eastern
Europe and South Africa. We are doing this because it will allow
us to strengthen our position along the Belt and Road. Second,
A freight plane unloads its cargo at the FedEx hub in Shanghai
40 / CKGSB Knowledge 2018
we have also launched direct flights from Guangzhou to Hanoi,
Mumbai, Delhi and other key Belt and Road cities. Also, our
acquisition of TNT in 2015 has allowed us to strengthen our
operations in Europe. The Belt and Road linking China to
Europe is important.
Q. E-commerce deliveries in China are forecast to reach nearly
50 billion this year. How much growth is left in this market?
A. We should not only look domestically, but focus more on cross-
border e-commerce. I’ll give you some numbers. Asia-Pacific as a
whole remains the world’s largest e-commerce market with sales
expected to more than double to $2.7 trillion by 2020. China plays
an important role in this, so for me this is just the beginning.
We are very much focused on the e-commerce business.
We have formed a new e-commerce division in the US. At
the beginning of this year, we acquired some e-commerce
transportation companies, including a UK company called P2P,
in order to further strengthen our e-commerce capability. And in
the US, we have made acquisitions in a lot of industries related to
e-commerce, such as fulfillment and retail logistics.
Q. How large an increase in cross-border shipments do you
expect to see?
A. What we expect to see more of is imports of goods to China
under the e-commerce umbrella. Actually, the Chinese government
is promoting this. Many Chinese tourists go abroad, buy stuff and
come back. They are doing that because a lot of goods are cheaper
overseas. But if the government sets up a good platform and
allows Chinese citizens to buy these goods in a legitimate manner,
then they could buy goods from all over the world without going
overseas. So, they can buy the goods cheaply, and on the other

hand, they have quite a lot of disposable income, which can be
spent locally. For me, that’s a win-win and that will be the trend
going forward.
Q. China’s logistics industry is automating rapidly with firms
experimenting with unmanned warehouses and drone delivery.
What are FedEx’s plans?
A. We make use of drones not only for package delivery, but
also for checking our facilities and our aircraft. We use artificial
intelligence to analyze data so that during the peak season
we know how to plan our routes and allocate our aircraft and
resources. We are also exploring the technology of “platooning,”
which allows us to manage our fleet of trucks and monitor fuel
usage, safety and efficiency more effectively. The big hot topic
at the moment is blockchain. FedEx is a charter member of the
Blockchain in Transport Alliance, as well as the Blockchain
Research Institute. FedEx Freight, our subsidiary company, has
a pilot project underway that uses blockchain technology to share
shipment information among suppliers, FedEx and retailers.
Q. FedEx recently opened a large hub in Shanghai. What
advantages will that bring?
A. The hub is the largest cargo facility of its kind in Pudong, the
industrial center in eastern Shanghai. There is over 100,000 square
meters of warehouse space and the sorting capacity is around
36,000 packages per hour. It also includes temperature control and
a customs clearance facility. Since we opened the hub, we have
added quite a lot of round-the-world flights.
Because Shanghai is the window to China, and because of
the economic opportunities in the Yangtze River Delta (YRD)
area that surrounds the city, it’s important to us. We have a large
operation in the YRD area and it also helps us take advantage of
the recently integrated customs clearance process. We can now fly
from northern or western China to Shanghai. Because of that, we
can fully utilize our flight network in China.
Q. Chinese logistics firms are looking to expand into overseas
markets. To what extent will this pose a challenge to FedEx?
A. These big companies in China logically will not be satisfied with
only serving the domestic market. They will expand overseas. So,
that is something that we already anticipated, and we take it into
consideration for our overall strategic development. We welcome
competition and we can’t stop other companies from doing what
they are doing. We can only control our own destiny.
Because of this, we are focusing on our long-term strategies.
First, we are expanding our global network because our business
is a network business. Second, we’re broadening our range of
services to meet different customer requirements. That’s the
reason why we are focusing on e-commerce and supply chain.
Third, we are focusing on technological deployment as a way to
enhance our efficiency and provide better services.
At the end of the day, I think good execution is the most
important thing, and our people play an important role. The secret
Fall 2018
We need to
monitor and
understand
the macro
environment, but
we can’t control it
of our success in execution is to make sure that we treat our people
well, provide a good environment for them to develop and give
them opportunities. Most importantly, we want their success to
be linked to the success of the company. We want to emphasize
that—we’re here for the long term; we want to do the right thing.
So, following the rules is very important.
Q. The US-China relationship appears to be entering a new
phase. To what extent does this context impact FedEx’s
operations in China and its plans for the future?
A. Overall, I’m cautiously optimistic. Why? Because the US is
the largest economy in the world; China is the second-largest.
Instead of having conflict, personally I see that they are more
complementary with each other and rely on each other. I think any
conflicts will be resolved in a satisfactory manner because both
governments are responsible for the well-being of their people.
Fighting with each other will not address the issues.
FedEx cannot control the macroeconomic environment. I keep
on telling my people that we need to monitor and understand the
macro environment, but we can’t control it. So, I would rather
focus on the opportunity side. If we are pessimistic, we will not
win.
The opportunities I see are how FedEx can benefit from Made
in China 2025. Under Made in China 2025, a lot of advanced
technological products will be produced in China and then they
will need an express service. We can take advantage of the
opportunities from the Belt and Road Initiative. We can focus on
how we can support SMEs and e-commerce, because the
government wants to do the right thing and express companies can
work with them to address this. So, I think that with our global
network, strong footprint in China and good customer service, in
the long run we will benefit from economic prosperity here in
China.
CKGSB Knowledge 2018
/ 41
 Fall 2018

NOT A HOLLYWOOD ENDING

Are US blockbusters losing their luster
in the world’s largest film market?
By Lu-Hai Liang

Image by José Luna

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Business Trends
Hollywood is
I
t is a scene to warm the hearts of
Hollywood executives. Friday night in
making more the trendy Sanlitun shopping district in
Beijing, and the movie theater is heaving
money in China’s with people eager to escape the stifling
August humidity and enjoy the latest
booming film summer blockbuster.
The film is The Meg, a US-China co-
market than production about a giant shark causing
chaos at an offshore research station, and it
ever. But US stars British action star Jason Statham and
Chinese actress Li Bingbing.
productions are Movies like The Meg are the great
white hope of the American film industry, a
losing market joint production with a Chinese studio that
beat the odds and succeeded on both sides
share to domestic of the Pacific. The film grossed $45 million
in North America and $50 million in China
rivals with bigger on its opening weekend.
Learning how to please mainland
budgets, sharper audiences without alienating moviegoers
in the United States is becoming important
scripts—and for Hollywood as box office receipts
stagnate in its home market but explode in
government China. Quarterly ticket revenues in China
surpassed those in North America for the
backing first time ever in the first three months of
2018, with Chinese cinemas netting $3.15
billion compared to $2.85 billion in Canada
and the US.
Those figures were boosted by massive
takings during the Lunar New Year holiday,
always a peak time for Chinese cinemas,
but China could become the world’s largest
film market in whole-year terms as early as
next year.
There are now more cinema screens
in China than the US, with the number of
Chinese screens doubling from 20,000 to
40,900 between 2013 and 2016. But there
are still only 23 screens per million people
compared to 125 in America, according to
researchers IHS Markit, suggesting huge
potential for further growth.
Hollywood studios are already looking
to China as their primary market in some
cases, according to Ben Fritz, author of The
Big Picture: The Fight for the Future of
Movies.
“Most big-budget Hollywood films are
made with the goal of making significant
money in China,” Fritz says. “Some
films—such as The Meg, Skyscraper and
44 / CKGSB Knowledge 2018
Rampage—are even produced with the goal
of earning most of their money in China.”
For many studio executives, China has
become the final hope for projects that have
bombed at home. Warcraft, the 2016 video
game adaptation, made only a quarter of its
$160 million production budget in the US
but grossed over $200 million in China.
Many other recent releases, from action
movie The Fate of the Furious to animal
flick A Dog’s Purpose, have performed
better in China than North America.
But there are also signs that Hollywood
should avoid taking this success for
granted. Though US movies are making
more money in China than ever, with
total revenues reaching a record $3.2
billion in 2017, they are increasingly being
outgunned by domestic productions.
While Marvel Studio’s Black Panther
generated over $100 million in China after
its March release, Operation Red Sea, an
action movie about Chinese troops stationed
in Yemen that debuted the same month,
grossed $579 million. This year has also
seen a string of other domestic successes
including Detective Chinatown 2 ($541
million), Dying to Survive ($451 million),
Hello Mr. Billionaire ($367 million) and
Monster Hunt 2 ($356 million). In fact,
of China’s ten all-time highest-grossing
movies, five are domestic films released
since 2017.
Chinese studios are still capable of
producing flops, such as Asura, the most
expensive domestic production ever, which
was pulled from cinemas in July after only
three days. But overall the swing toward
made-in-China movies is clear. Though
Hollywood’s share of the Chinese box
office held steady at 40% in 2017, it is
likely to decline this year. Foreign movies
only generated 40% of total revenues
during the first six months of 2018, down
from 60% last year.
Changing Fortunes
This is a far cry from the start of the decade
when American bullishness about the
Chinese film market was high. When the
James Cameron epic Avatar was released
in 2011, it grossed $195 million in China,
nearly double the record for a domestic

movie at the time.
Hollywood was then regularly
accounting for over 50% of total box office
revenues in the mainland, despite China’s
strict quota on foreign movies limiting the
number of releases to 20 per year. Optimism
soared further in 2012 when China raised
the quota to 34. Yet, in the following years,
the domestic film industry gained ground.
The key to this success has been a rapid rise
in standards.
“Before, there were a couple of critically
acclaimed directors, like Zhang Yimou, but
it was generally acknowledged that China’s
film industry wasn’t competitive with
Hollywood,” says Andy Mok, a lecturer
on American filmmaking at Chinese
universities.
The restrictions on foreign movies
gave the Chinese industry space to develop
without being crushed by competition
from Hollywood. In this, China learned
from the experiences of its neighbors.
Taiwan opened up its film market and
saw its domestic industry collapse, with
foreign movies now taking up to 95% of
box office revenues. But South Korea still
has a thriving film and television industry
that has benefited from strict quotas on US
imports.
“The improvements have mostly
been technical,” says Mok. “The whole
ecosystem of scriptwriters, producers,
directors, actors and post-production has
really come a long way in the past ten
years.”
An industry shakeout has also helped
BEIJING
BLOCKBUSTERS
Total box office revenue, 2012-H1 2018
China US
$ Million
12
9 Furious 7 (2015)
6
3 Kung Fu Yoga (2017)
0 0
2012 2013 2014 2015 2016 2017
Source: Box Office Mojo, Entgroup, Maoyan Movie, SARFT
Fall 2018
talent rise to the top, according
to Joan Xu, a Beijing-based
screenwriter.
“Three years ago, it was
stupid money [flowing around
China’s movie business],”
says Xu. “There were a lot of
young production companies
who weren’t experienced. A
lot have now gone and it’s
clearer who has the actual
experience.”
Chinese movies were
once notorious for focusing
on special effects rather than
storylines, but this perception
is shifting as more studios
commission scripts that tap
into Chinese socio-cultural Jason Statham and Li Bingbing promote The Meg in Shanghai
realities. The best recent
example of this is Dying to Survive, a gritty done a better job at catering to audiences
tale of a small-town drugstore owner that in the smaller cities,” says Charlie
became an unexpected hit in June. The Coker, Managing Director at Dasym, an
film’s success even led Premier Li Keqiang investment group that focuses on media co-
to promise to do more to make cheap productions in China.
medicine more easily available to Chinese
patients. New Storylines
Domestic movies have also been Foreign studios are trying everything to
buoyed by the massive build-out of cinemas appeal to Chinese audiences. George Ding,
across China’s smaller cities, where a Chinese-American screenwriter who
moviegoers tend to find local productions moved to Los Angeles from Beijing, says
more relatable. Theaters in third-tier cities that he is constantly sought after for advice.
and towns accounted for 43% of total box “American producers working on stuff
office revenues in the first half of the year, often want a Chinese pass on it—‘how
according to data from investment firm does this play with Chinese audiences? Is
Tianfeng Securities. it Chinese enough? Can this character be
“Domestic companies have definitely Chinese?’” he says.
China is set to overtake the United States as the largest film market in the world,
and most of this growth is being fuelled by domestic productions
Viewers per film screening in China China’s all-time highest-grossing movies*
$ Million
Top 10 Chinese films Top 10 US films Wolf Warrior 2 (2017) 874
40 The Mermaid (2016) 522
The Fate of the Furious (2017) 411
Monster Hunt (2015) 375
373
20 Never Say Die (2017) 339
Transformers: Age of Extinction (2014) 304
270
Mojin: The Lost Legend (2015) 259
2018 2012 2018 The Demons Strike Back (2017) 255
* Data valid as of January 2018
CKGSB Knowledge 2018
/ 45
Business Trends
Blockbusters now routinely feature
Chinese actors. Iron Man 3 even shot
an extra scene featuring starlet Fan
Bingbing especially for the Chinese
market. But such ham-fisted efforts
often provoke groans among Chinese
moviegoers.
According to Cristiano Bortone,
Managing Director of Bridging the
Dragon, an association connecting
European and Chinese film
professionals, film companies from the
West are realizing they need a deeper
appreciation of Chinese tastes.
“There is more understanding that
one has to put effort into expressing
what resonates with Chinese viewers,”
says Bortone. “Stories need to address
local themes and concerns.”
For some, the answer is to keep
things simple. The best-performing
Hollywood products in China in recent
years have been action movies with
easy-to-follow plots, including The
Fast and the Furious and Transformers
franchises.
Dying to Survive was a surprise hit
Donnie Yen, the Hong Kong actor,
made a similar point when he contrasted
the success of Marvel to the toils of Star
Wars in the Middle Kingdom. “Chinese
audiences didn’t grow up with Star Wars so
unfortunately it didn’t work,” Yen said in a
recent interview. “Marvel is a lot easier to
understand.”
Hollywood also hopes to gain greater
market share by convincing China to
loosen its market restrictions. There was
growing confidence in the US that the
two sides were close to agreeing a deal
Film quotas are exactly the kind of
target the Chinese would threaten in
response to [US] tariffs
American Enterprise Institute
46 / CKGSB Knowledge 2018
raising China’s foreign movie quota to as
high as 50 and addressing other issues like
“blackout” periods, when cinemas only
screen domestic features.
But a US-China trade war could lead
to the opposite scenario, with American
films facing even tougher barriers. “Film
quotas are exactly the kind of target the
Chinese would threaten in response to
[US] tariffs—China prefers smaller but
high-profile targets,” said Derek Scissors, a
resident scholar at the American Enterprise
Derek Scissors
Institute, in a recent interview with Variety.
Chinese regulators could allow movies
from other markets, such as Europe and
India, to take up more slots in the foreign
movie quota at Hollywood’s expense.
Beijing’s hand has been strengthened by
the increasing popularity of Bollywood
movies. The comedy Dangal grossed an
astonishing $180 million in China last
year, double the amount it made in India.
Double-Bill
These pressures are likely to make Chinese
co-productions like The Meg even more
important for Hollywood. Co-productions
are not subject to the foreign movie quota,
and so offer a way round any market
tightening.
Co-productions have had a mixed
record during their short history.
Enthusiasm waned following the 2016
release of The Great Wall, a big-budget
project directed by Zhang Yimou and
starring Matt Damon. The movie was
profitable but considered a failure in both
the US and China. But the success of Kung
Fu Panda 3 and The Meg have rekindled
studios’ interest.
“I think there will be more co-
productions after the success of The Meg,”
says Fritz. “American studios are aware
that local productions are succeeding
more frequently than they used to, and
one way they are adapting is looking
for opportunities to produce films in
partnership with Chinese companies.”
Finding the right blend of the two
cultures is not easy. But Hollywood and the
Chinese studios are getting closer as both
sides seek to learn from each other, as Josh
Linder, organizer of the Beijing Indie Short
Film Festival, emphasizes.
“I expect we’ll see more Chinese
studios shooting abroad, using established
Hollywood crews on films made exclusively
for mainland China and adapting proven
Hollywood scripts for the Chinese market
with exclusively Chinese casts,” says
Linder.
“Globally, successful films are
collaborative efforts that require the
participation of companies based in
countries all over the world.”
 Fall 2018

Mending China’s
Data Fences
Online data theft is rife. Will new data
protection rules fix the problem?
By Mark Andrews

Image by Yu Mu

CKGSB Knowledge 2018

/ 47
Business Trends

Online data
F
ilm director Jean-Luc Godard once company’s global operations,” Laura Reed,
said that art has the power to reveal a senior research analyst at Ranking Digital
theft is rife in our most secret selves. For visitors to
artist Deng Yufeng’s exhibition Secrets in
Rights, commented.
But things may be about to change
China, affecting Wuhan in April, this proved truer than they
could ever have imagined.
for China’s leak-prone tech giants. In
May, the government implemented new
more than 80% Those entering the gallery found a wall
of blue screens displaying the personal
data protection rules called the Personal
Information Security Specification.
of internet information of thousands of people: names,
ages, heights, telephone numbers, bank
Some analysts have hailed the
Specification as a watershed for data
users, and tech details and even train ticket purchases.
Deng had purchased the data online for just
privacy, with a few even comparing it to the
European Union’s game-changing General
companies often a few yuan each.
Police quickly shut down the exhibition
Data Protection Regulation (GDPR) law.
While there are important differences
display a cavalier and placed Deng under investigation, but
the artist had successfully highlighted the
between the two, Beijing’s new rules
appear to reflect a wider shift in the way
attitude to using ease of purchasing citizens’ details on the
black market. Data theft is rife, affecting
the Chinese government, companies and
consumers perceive online privacy.
people’s personal more than 80% of the country’s internet
users, according to the Internet Security Private I
information. Society of China. Whereas the average data
breach in the United States involves 1,458
Until recently, there was a widely held
belief that consumers simply did not care
But there are records, in China it is 11 million.
Many tech companies, both big and
as much about their privacy as people in the
West. China has historically approached
signs that things small, have a cavalier attitude to the use
and sharing of netizens’ data. In its 2018
the idea of individual privacy differently.
The Chinese word for privacy, yinsi,
could be about to survey of 22 major global internet and
telecommunications companies, Ranking
is a homonym of the word for “personal
secrets,” and word developed a negative
change Digital Rights scored Baidu bottom
among global internet firms and Tencent
connotation after the Chinese Communist
Party came to power in 1949. The right to
third worst. privacy was only added to the constitution
“Baidu and Tencent disclosed hardly in the 1980s, and even then this offered
any information in the Governance category, little real protection.
which means they are lacking disclosure of Past studies have also seemed to
commitments to freedom of expression and indicate a lack of concern for data security
privacy principles and measures taken to in China. A 2013 survey of consumers
implement those commitments across the in 12 countries by the Boston Consulting

Chinese consumers dislike spam calls

and emails just as much as everyone
else, but until recently that wasn’t
perceived as a privacy issue

Sara Xia
Attorney
Harris Bricken

48 / CKGSB Knowledge 2018


Volunteers redact sensitive information at Deng Yufeng’s exhibition Secrets, which
displays the data of 300,000 people
Group found that 75% of respondents
outside China considered it important
to be cautious when sharing personal
information online, but only 50% of
Chinese respondents agreed.
Baidu CEO Robin Li, then, probably
felt like he was swimming with the tide
when he told an audience in March this
year: “I think Chinese people are more
open or less sensitive about the privacy
issue. If they are able to trade privacy for
convenience, for safety, for efficiency, in
a lot of cases they’re willing to do that.”
But the furious reaction, with a string
of negative headlines and social media
commenters accusing the tech billionaire
of being “shameless,” showed he had
badly misjudged the public mood.
There is growing evidence that
consumers are starting to take the security
of their personal information seriously.
In a survey by Tencent’s research arm
Penguin, published in August, only 4% of
people reported having no worries about
data privacy, while 35% said they were
constantly anxious about it.
Pushback against the tech companies
is also growing. In January, online
payment giant Ant Financial was forced
to apologize for enrolling customers in its
Sesame Credit scheme, which tracks users’
behavior and personal networks, without
permission. The same month, a consumer
group sued Baidu for monitoring users’
phone calls without their consent.
“It’s not that consumers didn’t care
about privacy before,” says Sara Xia,
an attorney at law firm Harris Bricken.
“Chinese consumers dislike spam calls
and emails just as much as everyone else
in the world, but until recently that wasn’t
perceived as a privacy issue.”
What has changed is that the costs
of data theft have become much higher
as consumers have moved their finances
online. Today, it is common for consumers
to manage their money entirely through
smartphones, from making day-to-day
purchases using mobile payment apps
Alipay and WeChat Pay to investing in
wealth management products.
“As daily transactions shift to the
online space it becomes clear that there
are major upsides but also risks,” says
Samm Sacks, a senior fellow at US think
tank Center for Strategic and International
Studies (CSIS). Her research focuses on
data protection law in China.
These risks became clear in 2016,
It seems the Chinese rules were very
much inspired by the EU’s GDPR. They
use the same types of ideas
Jared Nelson
MWE China Law Offices
Fall 2018
when Xu Yuyu, an 18-year-old student
from a poor family in Shandong Province,
died of a heart attack after being conned
out of her tuition fees. The scammer
had reportedly paid a hacker to steal her
financial details.
The trend among online services, such
as WeChat, to require users to register
using their real names and phone numbers
is also worrying consumers. “That
awareness creates more concerns about
privacy,” says Jared Nelson, a partner at
MWE China Law Offices.
Online lenders have a record of
accessing debtors’ contact lists and then
harassing their friends and family members
with threatening phone calls. In one
extreme case, a company even paid local
pensioners to follow around customers with
a megaphone in an effort to shame them
into repaying their loans.
A New Order?
The big question is to what extent the
Personal Information Security Specification
rules force companies to change their
behavior. Analysts remain sharply divided
over this issue.
On paper, the Specification appears
similar to the EU’s GDPR law. “There
are places where it seems the rules were
very much inspired by the GDPR,” says
Nelson. “They use the same language,
the same types of ideas, the same types of
restrictions.”
This suggests that China may be
inclined to follow the European approach
to online regulation, which imposes strict
Partner
CKGSB Knowledge 2018
/ 49
Business Trends
Robin Li (left), Jack Ma (center) and Pony Ma (right), the heads of Baidu, Alibaba and Tencent respectively, speak at the World
Artificial Intelligence Conference in Shanghai. The three firms are founding members of the "national team" created by Beijing
in 2017 to make China a world leader in AI
rules on tech companies, rather than the
more laissez-faire American model.
As with the GDPR, the Specification
not only states that companies must obtain
the explicit consent of users to collect data,
but it also says that companies should
only obtain data that is necessary to the
functioning of their services.
This means that, in theory at least, tech
companies will no longer be able to force
users to grant access to a huge range of data
when they download an app, as has been
the case in the past. A recent investigation
of 200 Chinese finance apps found that 95
asked to read users’ text messages and 97
wanted access to customers’ contact lists,
according to the Financial Times.
However, there is one crucial difference
between the Chinese and European rules
that is causing confusion. GDPR is a law
with clear penalties, but the Specification,
despite laying out detailed requirements, is
merely a set of guidelines. Designed to add
flesh to the bones of China’s Cybersecurity
Law, which came into effect in June 2017,
the Specification only advises companies
on how they should comply with the law.
“If a company’s data practice is
inconsistent with the Specification, it is not
50 / CKGSB Knowledge 2018
automatically in violation of any law,” says
Xia, of Harris Bricken.
Nevertheless, Sacks insists that the
Specification will be far from toothless.
“If regulators wanted to crack down on
a company they could use this as a tool
to do an audit,” she says. “While it’s
not necessary for everyone to comply,
companies that don’t are vulnerable if there
is some sort of ad hoc enforcement.”
Many companies have rushed to hire
compliance officers and data protection
lawyers to help them comply with the new
regulations. According to Nelson, most
internet companies are not even close to
full compliance, but in general firms see the
rules as something they should follow.
“The government has already been
enforcing the rules in place,” says Nelson,
adding that his clients in a variety of
industries have received questions about
their websites and WeChat accounts.
Data Wars
China is still in the early stages of
deciding how strictly it wants to clamp
down on data-hungry tech companies.
While it is under pressure from data
protection advocates, it is also wary of
harming emerging industries like artificial
intelligence (AI).
Beijing has identified AI as one of ten
strategic industries that it wants to lead
in the future. In the global AI race, the
ability of Chinese companies to hoover
up vast volumes of data on the country’s
900 million internet users is widely seen
as giving them a head-start. As a result,
the government may be hesitant to restrict
access to the world’s largest data reserves.
“Companies right now are moving
aggressively to be innovators in the AI
space, and to do that they need to train
algorithms using datasets with lots of
information,” says Sacks. “If you overly
restrict the companies with these rules,
you undermine Beijing’s goal to be a
global AI leader.”
Other experts are more optimistic that
Beijing can reconcile data protection with
the needs of the country’s tech industry.
As an executive at e-CarX, a connected-
car system developer owned by auto group
Geely, points out, personal information is
of little value for many big-data products.
“We are unable to identify a user and
see where they went on any given day,”
says the executive, who is speaking on
 Fall 2018

condition of anonymity. “In fact, the data

of individual users is not useful to us; it is
only useful when data from all our users
is pooled.”
This is not the case in other industries,
such as e-commerce, digital advertising
and facial recognition. But even in these
industries, some argue that the value of
truly enormous datasets is overrated.
“Data is a key input into AI research
and drives forward commercialization,
but at a certain point having more data
brings diminishing marginal returns,” says
Jeffrey Ding, a researcher at the University
of Oxford’s Future of Humanity Institute.
According to Ding, global companies
like Facebook have an advantage in terms
of the breadth of data they hold, while
Chinese companies have the edge in terms
of the depth of their datasets. But because
this data relates mostly to China, it may be
of limited use when developing products
for overseas markets.
When it comes to innovation in AI,
other reforms could have a far greater
long-term impact than the data protection
rules. One example is the government’s
mooted plan to force AI companies to pool
their data in public shared databases.
If implemented, the public databases
would be a game-changer for AI
researchers across the world, but the move
would be highly disruptive for leading tech
giants, which guard their data jealously.
If you overly restrict companies, you
undermine Beijing’s goal to be a
global AI leader
Samm Sacks
Senior Fellow
Center for Strategic and International Studies
According to Ding, the policy would also
be tough to implement as companies use
different data protocols.
And there is another reason why the
government may disregard the lobbying
of the tech industry and prioritize data
protection. Beijing has called for the
creation of a national social credit scheme
by 2020. The project functions like a credit
scoring system and is designed to make
up for the fact that a large percentage of
people in China have no credit history
at all—the country has only 300 million
credit card users.
But the social credit system goes much
further, drawing on a huge range of user
data from online platforms such as Alipay
to assess a person’s overall trustworthiness.
Existing trial systems use a carrot-and-
stick approach to reward users with high
scores and punish misbehavior—for
example, by banning users from buying
train or plane tickets.
At the moment, there are no signs of
a widespread pushback against the social
credit system, but this could change if
public trust in companies involved in the
project, such as Ant Financial, deteriorate.
“Growing awareness toward misuse of
user data could ensure that any social credit
system must have limits on the extent to
which it collects personal information on
citizens,” says Ding.
“[The government] runs the risk of a
public backlash, like the one suffered by
Ant over Sesame Credit, if the public fails
to see the use of the social credit system as
legitimate,” agrees Sacks.

A YEAR OF LEAKS A series of huge data breaches have rocked the Chinese internet in 2018

Mobile Carriers
Hackers steal
3 billion pieces
GOMO of customer data
Popular app developer from state-owned
accidentally leaks networks China
data from more than Mobile, China Unicom
50 million users and China Telecom

Food Delivery Apps 51job.com Huazhu

Ele.me and Meituan- Account information Personal information
Dianping apologize from 2 million users from 130 million
after reports reveal of popular job portal customers is stolen
customer user data can found for sale online from the country’s
be purchased online from largest hotel chain
$0.02 each

Source: IDC Worldwide

CKGSB Knowledge 2018

/ 51
Business Trends
Unicorn Factory
China will soon have more billion-dollar startups than the United States, predicts
Hans Tung of GGV Capital, a global venture capitalist who has invested in firms
including Airbnb, Bytedance and Xiaomi
H
ans Tung knows how to spot a unicorn. During his career,
he has invested in 11 startups that have gone on to attain
billion-dollar valuations, including Airbnb, Bytedance,
Slack, Wish and Xiaomi.
As that list suggests, Tung is also one of the
few venture capitalists that feels equally at home
on both sides of the Pacific. A native of Taiwan,
he moved to California aged 13 and began his
career in Silicon Valley, before becoming one
of the first VCs at a US firm to move to China
full-time in 2005. Since moving back to the
United States in 2013, he has continued to invest
in both markets.
Tung explains why US and Chinese founders
can learn a lot from each other and how his
approach to investing differs for each country.
Q. What do you look for in a startup?
A. As background, GGV Capital started in 2000
in Silicon Valley, and then we opened our first office in Shanghai
in 2005. Since then, we have added offices in Beijing and San
Francisco, we are opening up in Singapore, and in a couple of
years probably in New York as well. In our portfolio we have
close to 300 companies, and of these there are 30 that are valued
at over $1 billion. So, we know how companies should scale.
What we look for are founders whose personalities and
background experiences are suitable for the markets they are
building. The founder and the product need to fit together. We
also want the market to be big enough so that we can have the
outcome of a billion-dollar company.
52 / CKGSB Knowledge 2018
Q. How early can you tell that a company has the potential to
become a billion-dollar company?
A. With a company like Xiaomi, I invested because I understood
what the founder Lei Jun was trying to do. His
vision made sense to me. Usually, we invest at
the series A or B stage, so the company is about
one to three years old. In the US, companies have
sometimes changed their model one or two times
by that stage before they found the right one. In
China, this happens less often. The founders tend
to be clearer about what they want to do from day
one. They may not get the products right the first
time, but the direction is set from the beginning.
Q. GGV Capital has investments in both the
United States and China. To what extent does
your approach differ for each market?
A. I think you need to figure out what development
cycle suits the country you’re investing in and
how mature the sector is in that country.
In general, we invest in three “buckets”—consumer, enterprise
and deep tech. In China, we tend to place more weight on consumer
and are increasingly adding more deep tech companies. Enterprise
is probably the smallest of the three sectors in China. In the US,
it’s the other way around. We invest in consumer and enterprise
heavily, but in deep tech we have only started to build a portfolio.
That’s because in the US we do see a lot of deep tech stuff, but
most of the companies don’t turn out to be very big. Consumer and
enterprise tend to produce a lot more unicorns in the US. In China,
most of the unicorns are coming from consumer, but there are also
 Fall 2018

on doing services and you can still become a super-app. Uber

appears to have learned this. At a couple of recent conferences,
Dara Khosrowshahi, Uber’s CEO, openly said that Uber is going
to do more than ride-sharing and food delivery in the future.
It will be more like a super-app for everything transportation-
related.
In addition, there is the marriage of social media and
commerce—what WeChat has done in partnership with
Pinduoduo. This is something that many US companies including
Facebook are experimenting with.
Another lesson Silicon Valley is learning is that if you are not
close enough to your manufacturers and don’t have new products
popping out quick enough, you’ll be at a disadvantage. Look at
companies like BGI. You have a deep tech product becoming
increasingly competitive on price and you’re seeing fast iterations:
new products are just coming out and cannibalizing themselves.

Q. What lessons does Silicon Valley still have to teach the

Chinese innovation community?
China’s bike-share movement has inspired startups across A. There’s still a lot of innovation in Silicon Valley, a lot of people
the world, such as US scooter-share firm Bird
trying new things. Even if those things don’t end up becoming
a lot of deep tech artificial intelligence companies growing, like big companies, you can still capitalize on what Silicon Valley
Face++ and SenseTime. has been working on, whether in the field of autonomous driving,
artificial intelligence or health care. In health care especially,
Q. The number of unicorn in China has skyrocketed and some Chinese companies still want to know what the latest cool gadgets
expect that there will soon be more unicorns in China than the are from Silicon Valley.
US. Do you agree? Given that Silicon Valley has world-class talent from
A. I think that’s right, and there are three reasons. First, China’s everywhere, as long as the immigration policy remains relatively
population and internet market are massive, the largest in the
world. There are 900 million internet users, whether that’s desktop
or smartphone. What’s more, China’s gross domestic product per
capita is close to $10,000 now. It’s still a developing country, but
the gap between it and the developed countries is a lot smaller In China, most
than before. When you have that kind of size and that kind of
development, it’s natural that you have more unicorns. of the unicorns
Second, the level of infrastructure—whether that’s high-speed
rail or subway systems—has penetrated enough in China to make
it easier for services and commerce to be developed. We had
are coming
companies that didn’t find it easy to go from point to point before,
but now the logistics development, urbanization and infrastructure
from consumer
buildup has reached a level where it’s much easier to build new
services on top. sectors, but
Third, the existing outside services, such as supermarkets,
shopping malls or credit cards, tend to be less developed in China
than elsewhere, so it’s a lot easier for Chinese companies to
there are also
leapfrog and do more.
lots of deep tech
Q. Are there lessons that Silicon Valley could learn from China’s
startup ecosystem? AI companies
A. I think the concept of the super-app is something that people
in the US are starting to pay attention to. Startups wanting to growing
become the “Amazon for services” are a perfect example. You
don’t have to be like WeChat, a social platform. You can focus

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Business Trends
The Chinese are
much better at
seeking out cool
things and working
out how to scale
them
open, it will always be a place that people flock to for the latest
innovations. Most of them may not turn out to be big companies,
but the Chinese are much better at seeking out things that are cool
and working out how to scale it.
Q. Much has been made recently about how the US and Chinese
tech communities are growing closer together. To what extent is
that the case?
A. What we’ve seen is that there are a lot of people moving back
and forth between the US and China. There are a lot of Chinese
engineers that get educated or start their tech careers in the Valley
before moving back to China.
We’re also seeing a lot of people from around the world
going to China now to find out what’s going on, and then taking
ideas back to their own countries. If you take bike-sharing as an
example, it started off in China with Mobike and Ofo and then
graduated to the US with LimeBike. Then, Bird rolled out electric
scooters. And now in Latin America, you have Grid in Mexico and
Yellow has moved into the same space in Brazil. The founders of
Yellow went to China before setting up their company.
Q. Tensions between the US and China have been growing. How
has this affected the emerging ties between the US and Chinese
startup scenes?
A. What has happened, especially given what happened to ZTE
(the Chinese telecom firm that almost went out of business after
being hit by US sanctions in April), is that there is a lot more money
and talent in China focusing on developing Chinese independence
in upstream components like microchips. So, you see more effort
being put into that, and that’s led to more people moving back to
China from the US to fulfill that need.
The more restrictions there are on Chinese investment in the
US, the more likely it is that Chinese talent in the Valley ends
up moving back to China. And the more that China is used as a
54 / CKGSB Knowledge 2018
punching bag by Republicans and Democrats, the easier it is for
Chinese talent to move back. So, it’s counterproductive. We always
think that politics is local, but you want tech-sharing to be global.
Q. Do you expect the US-China tensions to be a passing phase or
the start of a longer-term shift in relations?
A. That’s hard to say. I’m cautiously pessimistic in the sense that
it’s hard to see how technology can improve the lot of people in the
heartland of America in the short term. If people in the heartland
of America are not happy and feel increasingly unable to improve
their fortunes, then China becomes an easy scapegoat for a lot of
the problems.
Q. Are the current tensions affecting the decision making of
Chinese companies looking to expand in the US?
A. It’s increasingly less likely that Chinese companies will do a
lot in the US. But quite frankly, it’s easier for Chinese companies
to expand into India, the Middle East and Southeast Asia. I think
those will remain the regions that the Chinese will go to.
Q. What are the main barriers that US companies face when they
try to expand in China? Are policy barriers the biggest obstacle?
A. I think cultural or technological barriers are more of a problem
than dealing with policy or regulation because the Chinese
government also doesn’t make it easy for local startups to expand
into new categories. Chinese startups have to figure out how
to work with the government to do the things that they do—
companies like Didi Chuxing and Meituan all went through that.
So, it’s a learning process for everybody in China to begin with.
However, if you’re trying to learn this from Silicon Valley,
where the founders are used to being successful elsewhere with
their set ways, it’s hard to figure out how to adapt to the Chinese
market and work with the government in a way that works for
both sides. So, I think it’s twice as hard for American startups to
succeed in China than for local startups.
Q. What will your investment priorities be in 2019?
A. We will always focus on our main categories of consumer,
enterprise and deep tech, but in China we expect to see more
enterprise investments coming up over the next five years. As
labor costs continue to rise, it’s inevitable that more enterprise
startups will be built because you will have companies looking to
increase revenue and become more efficient without hiring a lot
more people.
On the consumer side, you’ll continue to see lots of businesses
being built through internet-based efficiency in agriculture,
commodities trading, as well as transportation and financial
services. These are all areas where we think that the internet will
continue to make a difference.
In deep tech, especially given what’s happening between the
US and China, you’ll see more government support in China and
a lot more entrepreneurs trying to make China more self-sufficient
in deep tech. You’ll see a lot of stuff happening there.
 Fall 2018

AFRICA CALLING
Image by José Luna

How a little-known tech company from Shenzhen

rose to dominate the African phone market
By Colin Peebles Christensen

CKGSB Knowledge 2018

/ 55
Company
Shenzhen-based
I
n the streets surrounding bustling
Kariakoo Market in downtown Dar es
smartphone Salaam, shoppers are ambushed by vast
banners stretched across the slab concrete
maker Transsion buildings. In red, white and blue, the
advertising promotes the biggest-selling
Holdings has smartphones in town. These are not
handsets from Apple, Samsung or even
followed an Huawei, but Tecno Mobile and Itel—two
Chinese brands that are barely known
unlikely path outside of Africa but have risen to dominate
the continent’s fast-growing market.
to success by Tecno and Itel’s parent company,
Transsion Holdings, is the dark horse of
largely ignoring China’s tech sector. Though the company
has a low profile in its home city of
its home market Shenzhen, the southern startup hub that is
also home to Huawei, Transsion sold 130
and instead million phones globally last year, just 23
million fewer than Huawei and nearly 40
focusing on Africa million more than Xiaomi.
Transsion enjoys a market share of
over 50% in Africa and is the top vendor
for both feature phones—cheaper handsets
with basic functions—and smartphones,
overtaking Samsung in 2017.
The company’s success has been
built on a decision, made two years after
it developed its first feature phone, the
Tecno T201, in 2006, to focus exclusively
on Africa. Transsion believed there was a
unique growth opportunity there.
“When our company was founded,
each of the emerging markets including
Africa, China and India boasted 1 billion
potential customers,” Arif Chowdhury,
Vice President at Transsion, told Chinese
news website Jiemian in a recent interview.
Tecno is changing the narrative that
Africans can’t afford smartphones
56 / CKGSB Knowledge 2018
“But comparatively speaking, competition
in the African market is less fierce.”
Moving to Africa allowed Transsion to
avoid Chinese rivals, but the company still
faced a daunting competitor in Nokia, which
was the leading player in the continent at
the time. The Chinese firm was very much
the underdog—the company’s first African
production facility, in Ethiopia, consisted
of six Chinese workers assembling phones
on the ground floor of a three-story villa—
but cheaper prices and superior localization
have seen it win out.
“Transsion has succeeded because
they addressed the problems of the market
directly. They make phones with features
that are attractive to Africans,” says
Aniekan Etetim, a Nigeria-based tech
expert and founder of the TechLifeCode
blog.
Tecno was the first brand to produce
phones with slots for multiple SIM
cards, allowing users to switch between
networks seamlessly. The feature proved
hugely popular in Africa, where coverage
is notoriously patchy and consumers are
highly price-conscious. The company’s
phones also offer extremely long battery
life to cope with unreliable electricity
supply. Some Transsion feature phones can
run for a month on a single charge.
This “glocal” approach has helped
Transsion build an enormous lead in Africa’s
feature phones market, where the company
has a market share of 59%, according to
figures by International Data Corporation
(IDC). Its tiny Ethiopian production line
has expanded to 1,600 employees and can
Mbwana Alliy
Founder
Savannah Fund

A sign advertising Tecno phones hangs above shoppers in Dar Es Salaam, Tanzania
produce 1 million handsets a month. In
total, Transsion has 5,000 workers based
in Africa, of which 90% are local hires,
according to the company.
Moving Up
Low-cost feature phones still remain the
company’s most popular products. But
Transsion has also tapped into rising
income levels in Africa to become the
region’s leading smartphone maker.
When Transsion launched its first
Android-based smartphone, the Tecno T1,
in 2012, smartphones were rare in Africa,
with only the highest earners able to buy
an Apple or Samsung. But the Chinese
company’s low prices made owning a smart
handset a realistic prospect for millions of
people.
“Tecno is changing the narrative
that Africans can’t afford smartphones,”
Mbwana Alliy, founder of the Africa-
based venture capital firm Savannah Fund,
told Bloomberg. “Facebook, Instagram,
WhatsApp—all those apps owe a lot of
their success to Tecno.”
Transsion’s low prices have allowed
it to undercut its main rival, Samsung,
and achieve a market share of 34% in the
African smartphone market, which now has
nearly 300 million users.
“Africa continues to be a price-
sensitive market with almost three-fifths
of total handset sales below $100,” says
Tarun Pathak, an associate director at
Counterpoint Research. “There are still
users who are now experiencing their first
ever smartphone and Transsion is wooing
these customers by providing aggressive
specs at an affordable price.”
Transsion’s cheap phones were once
perceived as unfashionable by African
consumers, and Etetim says several of
his friends used to cover the Tecno logo
on their handsets with tape. However, the
company has moved up the value chain and
is increasingly competing directly against
other global brands, launching a higher-
Fall 2018
end, smartphone-only brand named Infinix
in 2013.
Highly localized “micro-innovations,”
such as cameras optimized for taking
flattering selfies of users with darker skin
tones, have helped Transsion’s brands
develop a reputation for quality as well as
price. The company has set up R&D units
in Kenya and Nigeria to further localize its
products.
With Africa’s smartphone market
predicted to triple in size to 930 million
users by 2021, according to analysts Ovum,
Transsion’s prospects appear bright. The
company expects its worldwide sales to
grow nearly 50% this year to reach 180
million units.
But the huge growth potential in Africa
is attracting the attention of the world’s
largest brands, including companies
Transsion previously tried to avoid. Huawei
is investing heavily in South Africa and
Oppo is building a presence in Kenya.
“Africa is likely to be the next
CKGSB Knowledge 2018
/ 57
Company

battleground in the global smartphone
market,” says Pathak.
The arrival of the Chinese brands
means that Transsion will have to adapt
to a more intense level of competition in
Africa, according to Ramazan Yavuz, a
research manager at IDC. “Transsion is
entering a phase of competition with the
bigger players where winning is largely
had challenges—that’s the risk KINGS OF AFRICA
that they have to take,” says
Zaagman. “But by doing that Transsion is now the most popular maker of feature
they can have the cheapest phones and smartphones in the African market
phones because they make them
Africa feature phone market share (%)
locally.”
2016 2017
These low prices and high 60%
brand reputation will help 50%
Transsion remain popular among 40%

dependent on spending and continuous first-time smartphone buyers.

30%
20%
product launches,” says Yavuz. Other brands are likely to target 10%
Huawei has a larger marketing users buying second or third 0
Transsion brands Nokia Alcatel Samsung
budget than Transsion and is expanding handsets, according to Pathak of
aggressively. But Transsion has higher Counterpoint Research.
Africa smartphone market share (%)
brand recognition and is better attuned to
2016 2017
the needs of its users. Tecno rose to seventh Out of Africa 30%
on Brand Africa’s list of the top 100 most Rather than focusing on 25%
admired brands in Africa last year, just five defending its “home” market in 20%

places behind Samsung and 19 ahead of Africa, Transsion is advancing

Huawei. Itel and Infinix also made the list,
in 16th and 28th positions respectively.
Transsion’s long-term investment in
relationship-building and training local
staff have helped promote brand loyalty,
believes Elliott Zaagman, a consultant at
Goldenspan Consulting who specializes in
China’s technology sector.
“Transsion has done a better job at
building goodwill with the local people,”
says Zaagman. “They have been there
longer, they’ve learned how to do it and
they clearly work better with African
governments, African consumers and
African workers.”
Another advantage is the company’s
extensive after-sales service arm, Carlcare,
which was set up in 2009 as a separate
brand. It now operates more than 1,000
touchpoints worldwide.
Yet, localization also brings its risks
in Africa, as political instability remains a
serious issue. Transsion closed its facility
in Addis Ababa temporarily following
the surprise resignation of Ethiopian
Prime Minister Hailemariam Desalegn
in February. The company also views
unstable government policies and foreign
exchange fluctuations as potential obstacles
to rolling out its next factory in Nigeria.
But Transsion’s manufacturing facilities
in Shenzhen, Huizhou and India offer the
company a degree of protection.
“Their Ethiopian manufacturing has
15%
10%
into new territory and opening 5%
up multiple new fronts in 0
Transsion brands
the battle with its rivals. The
Source: IDC Worldwide
company’s top priority has
been India, where it is expanding its sales
network, scaling up its factory outside New
Delhi and launching new R&D centers.
Transsion acquired Indian tech firm Spice
Mobility last year and revived the Spice
brand with fresh product launches.
“The competition in India has turned
white-hot,” Chowdhury told Jiemian. “If
we do not enter the market now, the door
will be closed to us permanently as smaller
brands will have little chance of surviving
in two or three years’ time.”
In April, Transsion also kick-started a
push into the Gulf region by launching the
shiny Camon CM smartphone in Dubai.
Chowdhury says the company also has
plans to expand into Indonesia, Vietnam,
Colombia and Mexico.
These new markets will prove more
challenging and Transsion will require
additional funding to succeed against well-
capitalized competitors. A ploy to list on
the Shenzhen Stock Exchange through
a reverse takeover of Chinese pumping
equipment maker Shimge Pump Industry
Group fell through in June, after the two
companies failed to agree on terms.
Still, Transsion hopes that its tried-and-
tested recipe—offering high-spec, highly-
localized products at highly-affordable
Samsung Huawei
prices—will win over consumers outside
of Africa too. The company’s Indian
phones already boast fingerprint scanners
optimized for greasier fingers, designed to
appeal to users in a country where people
prefer to eat with their hands.
Transsion is currently in fourth place
in India’s feature phone market with a
7.6% share, according to IDC. However,
in smartphones it languishes in fifth place
with a share of 5%, below Oppo, Vivo,
Samsung and Xiaomi, which leads the way
on 29.7%.
Upsana Joshi, an associate research
manager at IDC India, believes that
Transsion will find it tough to move up
the rankings. “Huawei, Xiaomi, Oppo
and Vivo have a decided edge in terms of
product placement, quality and promotional
spending,” she says.
But Transsion’s lower-end products
could be highly competitive in India,
given that 85% of sales are for handsets
costing less than $200. The company’s
strong offline channels with above-average
margins for retailers and distributors will
also be an asset.
And as Samsung and Nokia have
discovered in Africa, it might be wise to not
write off the underdog.

58 / CKGSB Knowledge 2018

Business Barometer

CKGSB BCI

Falling Confidence
Sentiment among private firms has deteriorated markedly during
the past two months. Beijing needs to take urgent action to arrest a
growing crisis

The BCI is directed by Li Wei, Professor of Economics

at the Cheung Kong Graduate School of Business

I
n October, the CKGSB Business Conditions Index (BCI)
dropped slightly from the worst reading to date in September,
from 41.9 to 41.4. Although not quite as dramatic a decline
as the previous month, the deterioration of conditions for doing
business in China should not be underestimated. It shows
that the majority of sampled companies, some of the most
competitive private businesses in China, are pessimistic about
their prospects for the next six months.
Introduction
Since June 2011, CKGSB has conducted a monthly survey
of executives about the macro-economic environment in
China called the Business Conditions Index (BCI). The BCI is
skewed toward small- and medium-sized enterprises (SMEs)
that are competitive in their industries, and so provides a
reliable snapshot of business sentiment among successful
private companies.
The BCI is a set of forward-looking diffusion indicators.
The index takes 50 as its threshold, so a value above 50
Business Conditions Index (BCI)
80
70
60
50
40
2012 2013 2014 2015 2016 2017 2018
means that the variable that the index measures is expected to
increase, while an index value below 50 means that the variable
is expected to fall. The BCI uses the same methodology as the
PMI index.
Key Findings
• Firms’ confidence regarding sales and profits rebounded
slightly to 61.2 and 45.3 respectively, but the scores remain
far below the levels typically seen over the past two years
• The financing situation for private firms is still dire, with
the reading of 25.0 a slight improvement on the previous
month but far below the baseline threshold of 50
• The decline in expectations regarding prices, with both
consumer and producer prices expected to fall in the
coming months, is a worrying indicator of a possible
significant economic slowdown
Analysis
Three of the BCI’s main sub-indices rose month-on-month and
one fell. The corporate sales index rose from 60.4 to 61.2, and
the corporate profit index increased from 43.0 to 45.3.
The corporate financing index had a minor rebound from
24.2 to 25.0, still well under the confidence threshold. It shows
that in terms of financing difficulties, companies are yet to turn
the corner.
The inventory index dropped significantly from 42.7 in
September to 37.2. This index was the only one to rise the
previous month, but has now returned to form. This drag on the
BCI may account for the overall index’s continued downward
trajectory.

60 / CKGSB Knowledge 2018

 Fall 2018

On October 7, the People’s Bank of China (PBOC) lowered

Corporate Sales and Profits
100 the RMB deposit reserve ratio for certain financial institutions
95 Corporate Sales Index by one percentage point, which would free up an estimated
90
85
RMB 750 billion ($108 billion) in capital.
80 There have also been calls from several high-profile figures
75 including Vice-Premier Liu He for the financial sector to lend
70 more to private businesses, a signal that policy makers are
65
taking this issue very seriously.
60
55
50 Corporate Profit Index 90 Investment and Recruitment
45
40 Investment Index
35 80
2012 2013 2014 2015 2016 2017 2018
70

On the prices side, the consumer prices index fell from 60

59.0 to 48.4, breaking through the confidence threshold. The Recruitment Index

producer prices index rose from 39.9 to 44.5. This continued

50
decline in expectations for prices shows us that without
government intervention, China could be in for a significant
40
economic downturn. 2012 2013 2014 2015 2016 2017 2018
We now turn to investment and recruitment. The investment
and recruitment indices have consistently remained at the more
confident end of the scale. However, the past two months have However, the policies and calls by decision makers have
seen the trend tip in the negative direction. The investment proved somewhat ineffective. They are examples of the
index is 54.3, and the recruitment index is 58.7, both under Keynesian notion of “Pushing on a String.” This metaphor
60. When businesses plan to invest less and recruit fewer staff, is widely used to describe how monetary easing is often
their confidence is clearly shaken. This is something to be powerless as a tool for accelerating growth, just as pushing on
taken seriously. a string is useless.
Examples of this phenomenon abound throughout history,
Inventory and Financing notably Japan’s large-scale quantitative easing measures,
70
which have consistently failed to solve the country’s problem
Inventory Index
60 of sluggish growth.
China and Japan have different national conditions, with
50 different specific problems. However, as in Japan, China has
a failed monetary policy. Although the Chinese government
40 has tried many ways to solve the financing and high costs
bottleneck for private enterprises, and has loosened monetary
30
Corporate Financing Index
policy, the data shows that private enterprises may only obtain
limited support.
20
2012 2013 2014 2015 2016 2017 2018
Why is this happening? There are many reasons, and one
of them is the relationship between state-owned enterprises
(SOEs) and private firms. There are deep institutional factors
Conclusion that have led banks to lend to SOEs rather than private firms,
One of the most concerning issues plaguing private firms forcing private SMEs to turn to the shadow banking sector for
continues to be the difficulty in accessing funding, as the low funding.
score of 25.0 for the financing index shows. Targeted measures It would be best to open up new financing channels for
to mitigate funding shortages are needed urgently. private enterprises while rectifying shadow banking, and open
Seen from recent measures put in place by decision makers, regulated financial institutions to allow private firms to compete
it is crystal clear they are aware of the financing difficulties and equally with SOEs on the capital markets. However, some
high costs private enterprises face, especially privately-owned significant structural reforms need to be enacted before this can
micro, small and medium-sized enterprises. happen.

CKGSB Knowledge 2018

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Business Barometer

CKGSB BSI

A Hidden Recovery
Despite the current market pessimism, conditions in China’s industrial
economy are improving steadily

The BSI project is directed by Gan Jie,

Professor of Finance at CKGSB

T
he CKGSB Business Sentiment Index continued to sents industry, region and company size. As a result, we are
indicate a slight expansion in the second quarter. The able to construct business indices that are, to the best of our
score of 51 marks the first time the BSI has remained knowledge, the most informative ones available about the
above the baseline of 50 since the survey began four years Chinese economy.
ago. This indicates that the fundamental conditions in China’s
industrial economy are continuing to improve, despite the Key Findings
current market pessimism. • Operating conditions reached a three-year high in Q2,
with a score of 58. Other signs of improvement included a
Introduction slight expansion in employment, electricity consumption
This report is based on data collected from our quarterly and overseas orders.
surveys of around 2,000 industrial firms in China. Conducted • This quarter’s expansion was mainly driven by state-
through telephone interviews, this study is now in its fourth owned and foreign firms, with the diffusion indices being
year, having launched in the second quarter of 2014. If we 59 and 55 respectively (Q1: 61 and 55). Private firms—
exclude the agricultural, real estate and financial sectors from the vast majority of industrial firms—stayed flat (50).
China’s GDP, the industrial sector now accounts for 50% of • Only 5% of firms indicated they were affected by the US-
the non-agricultural economy. China trade war and 1% reported a significant impact.
Our survey design ensures that our sample fully repre- Not surprisingly, affected firms are mainly those with
exports, which account for 31% of our sample.
Business Sentiment Index
Current operating conditions Expected operating conditions Analysis
Investment confidence Business Sentiment Index
Similar to Q1, our major indices in Q2 generally remained
70
stable. Both employment and electricity consumption
60
46 47 48
51 51 increased slightly (51), while inventory levels and production
50
40
stayed flat (50).
30
Due to rising costs, product prices continued to increase,
20 with the diffusion index standing at 53. Cost rises were the
10 driving force behind the price rises in Q2. Among firms with
0 product cost inflation above 5%, cost rises were the most
prominent.
Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018

62 / CKGSB Knowledge 2018

 Fall 2018

Weak demand is still by far the biggest challenge for the problem was more prominent among private firms (30%) and
industrial economy. More than 60% of the firms surveyed in firms producing capital goods and intermediate goods (38%
Q2 cited a lack of orders. Costs were listed as the second larg- and 33%, respectively). SOEs were disproportionally more
est issue, with raw material and labor costs both cited by 19% likely to delay payment, accounting for about 11% of all firms
and 12% of firms, respectively. that have done so.
Overcapacity means a lack of pricing power, which,
Factors Constraining Production of Next Quarter combined with rising costs, results in low profit margins.
Q2 2018 Q1 2018 Q4 2017 Q3 2017 Q2 2017 As many as 21% of the firms surveyed had gross margins
80% below 10%, while the proportion of firms with gross margins
above 15% increased to 36% (Q1: 35%). Thus, overall gross
70%
60%
50% margins improved slightly.
40%
30%
Gross Margins
20%
Q2 2018 Q1 2018 Q4 2017 Q3 2017 Q2 2017
10%
60%
0%
Lack of Raw material Labor cost Macro industrial Financing Environmental 50%
ordrs cost policy concerns
40%

The weak demand is the result of the severe overcapacity 30%

that continues to affect industrial firms. In Q2, close to two- 20%
thirds (65%) of the firms reported oversupply in the domestic 10%
market, with a diffusion index of 82 (Q1: 81), still close to 0%
historically high levels. However, there are some signs of 0-5% 5-10% 10-15% 15-20% >20%

progress. About 59% of firms reported a capacity utilization

rate above 90%, up from last quarter’s 57%, though the As with our previous surveys, we found that financing is
proportion of firms with capacity utilization rate below 70% not a bottleneck for the industrial economy. In Q2, only 1%
increased to 14% (Q1: 12%). of firms cited financing as a constraining factor (2017: 2-3%).
Overall, 22% of firms said they had sufficient funds, 76% an-
Firms with Severe Excess Capacity swered “neutral,” while only 2% reported insufficient funds.
Only a small fraction of firms (1.5%) obtained new loans in
Q2 2018 Q1 2018 Q4 2017 Q3 2017 Q2 2017
40 Q2. When asked about the reasons, the vast majority of firms
35 without new loans (99%) reported that they did not have the
30 need for capital.
25
20
15 Conclusion
10 Overall, based on our industrial survey and macro data, we
5
note that the current market pessimism does not arise from
0
% of above 10% % of above 20% # of industries with # of provinces with the economic fundamentals, but rather is caused by sentiment
overcapacity overcapacity severe overcapacity severe overcapacity
due to the trade war, structural problems of the Chinese econ-
omy and the effort to reduce leverage. The recent proposal
There is no consensus as to what level of capacity of monetary easing to pump up the economy is shortsighted.
utilization should be considered healthy. However, if we take The vulnerability of the Chinese economy comes from its
the examples of the two largest western industrial nations, the structural problems including a lack of core technologies in
US and Germany, their monthly average capacity utilizations some areas and high level of debt due to persistently loose
were 79% (1994-2015) and 83% (1992-2015), respectively. monetary policies.
Their lowest points after the financial crisis in 2008 were The current situation calls for a new round of economic
67% and 70%, respectively, both measured in June 2009. reform and institution-building. China still has a number of
Given the low profit margin of Chinese industrial firms, their areas with great potential that, if properly developed, could
sustainable utilization rate may be higher than that of their sustain the country’s long-term growth. These areas include
western counterparts. domestic consumption, technology innovation, urbanization
Consistent with overcapacity and the resulting lack of and reform of state-owned enterprises. We believe the best
orders, 28% of firms reported difficulties in collecting trade strategy to insure against external shocks is to enhance the
receivables from their customers in 2018 Q2 (Q1: 28%). This system’s internal strength.

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Downtime

the big
cover-up
Chinese millennials are getting tattoos
in record numbers, but some are
being forced to keep them hidden
By Timothy Ang

Z
 huo Danting is no poster child for middle-class Chinese
 conformity. With her long neon-green hair, gaping plug
 earrings and gothic sense of style, the 35-year-old tattoo
artist provokes double-takes even on the streets of relatively liberal
Shanghai.
But though she may not fit in at their parties, Zhuo is a darling
of the city’s moneyed elite. Fashionistas, financial workers and
fuerdai—the children of the city’s nouveau-riche—line up to get
inked at her grungy studio, located in the prestigious former French
Concession area. A design by Shanghai’s “queen of tattoos” can
cost $3,000 or more.
Tattoo culture has exploded in China in the last few years, as
Image by Cadie Can Long

the country’s younger generations abandon centuries-old prejudices

against the practice and embrace it as an expression of individuality.
When Zhuo, a native of Harbin in China’s far north, set up her
first studio in Shanghai in 2007, there were “maybe a handful” of
tattoo parlors in the city of 20 million people, she says. Today, there
may be up to 4,500, according to Jing Xi, author of the popular blog
Patch Tattoo Studio, and as many as 300,000 nationwide.

64 / CKGSB Knowledge 2018


Tattoos are now an everyday sight
on the streets of China—especially in
Shanghai, which has been dubbed China’s
“tattoo mecca.” Since 2015, the city has
celebrated its flourishing tattoo culture at
the annual Tattoo Extreme Expo. Held each
August, it attracts over 20,000 visitors. In a
sign of the growing mainstream appeal of
tattoos, this year’s expo even drew families
with small children in tow, who enjoyed
practicing their needle skills at the event’s
“tattoo school.”
Tainted Past
This change in attitudes is extraordinary
given the depth of the stigma against
tattoos in Chinese culture, which dates back
two millennia to the times of Confucius.
At the beginning of the Classic of Filial
Piety, believed to have been written 2,500
years ago, the Great Sage explains that the
sanctity of the body was the basis of filial
respect.
“In Confucian culture, you’re supposed
to return your body to the ground as your
parents gave it to you, unblemished, no
piercings or tattoos,” says Carrie Wiebe,
Professor of Chinese at Middlebury College
in the United States. “That’s still a closely-
held value to some people, but in the
traditional period tattooing was really one
of the most unfilial things one could do.”
Over the centuries, tattoos also acquired
a criminal connotation. Convicts, military
deserters and prostitutes were often tattooed
as a permanent reminder of the sins they
had committed. “These were signs of
shame that would stain you forever,” says
Wiebe.
When China’s organized crime groups,
the “Triads,” emerged in the 18th and
19th centuries, their tattoos acted both as
proof of membership of a particular gang
and of their status as outlaws. When Mao
Zedong’s Communist Party took power,
tattoos were doubly condemned as not only
a mark of loose morals but also proof of
an unhealthy bourgeois individualism. As
Weihe Xu, also a professor at Middlebury,
explains: “Revolutionary heroes never had
tattoos.”
These prejudices persist in many parts
of Chinese society, particularly among the
Zhuo Danting, a Shanghai-based tattoo
artist
elderly, according to Zhuo.
“The bad feelings mainly come from
the older generations,” she says. “They
look at someone with tattoos and think:
‘This is a kid with no future.’”
Some employers still frown on
employees with ink. An investigation
of factories run by manufacturing giant
Foxconn by China Labor Watch in June
found that managers check new hires for
tattoos. The People’s Liberation Army,
meanwhile, only relaxed its zero-tolerance
stance toward ink in 2011. Applicants with
face or neck tattoos that do not exceed two
centimeters in width can now enroll.
Many young people still worry about
In the traditional period, tattooing was
one of the most unfilial things one
could do
Professor of Chinese
Middlebury College
Fall 2018
the consequences of getting inked for the
first time. Hai Xiang, a personal trainer
in his late twenties, recalls fearing that
he might risk his career before getting
his tattoo, a portrait of martial arts legend
Bruce Lee on his upper arm.
“I thought that this was always going
to be something that I would have to hide
from my bosses, or at interviews,” says Hai.
“When I was young, my parents would tell
me again and again how no one would ever
hire me if I had piercings or tattoos.”
But the generations born after 1980,
with no memory of the austerity of
the Cultural Revolution, are gradually
challenging these attitudes.
“Many of the younger generation to
whom tattoos are appealing have something
of a cultural amnesia about what happened
in the 1960s and 1970s,” says Wiebe. “They
aren’t afraid of expressing themselves.”
The shift began slowly but has
accelerated in recent years. Liao Xiao, a
student at Shanghai International Studies
University, remembers online memes
circulating around his college a few years
ago.
“There was a picture on social media
of a foreigner with a full-sleeve helping an
old homeless Chinese woman,” says Liao,
who is in his early twenties. “The caption
read: ‘not all people with tattoos are bad
people’—like it was a new idea.”
And the pace of change has accelerated,
according to Zhuo. Her studio now has
a long waiting list. “We’ve become more
and more successful in terms of revenue
and have multiple bookings every day of
Carrie Wiebe
CKGSB Knowledge 2018
/ 65
Downtime

the week and open late into the night,” says

Zhuo.
Where once her clientele was drawn
mainly from Shanghai’s expat community,
today Chinese millennials with high
incomes make up half her bookings, and
this segment is growing fast. Even young
women are shunning paternalistic traditions
and openly displaying their inkwork in
public.
“What my female clients are asking
for is changing,” says Zhuo. “It used to be
something small and easy to hide, but now
they want sleeves and images on, say, the
neck.”
Gang Shao, a veteran tattoo artist who
has developed a cult following in Shanghai,
believes that the rise of individualism has
made tattoos more desirable to Chinese
millennials.
“Five to ten years ago, everyone who
came into my shop would go straight to
the flash book of set designs,” says Gang.
“Now, it’s more acceptable to explain their
idea to an artist who can design something
special for them.”
One of Gang’s young pupils, who goes
by the English name Leo, explains that
his tattoos are deeply personal. “I want to
remember some things or people which
have been important in my life,” he says. Visitors get tattoos at the Tattoo Extreme Expo in Shanghai
On Leo’s left arm is written the Chinese
idiom “act according to one’s capabilities,” the government ordered any musician Two months later, China’s soccer
which his grandfather often said to him as a or actor with a tattoo to be banned from players were targeted by a directive stating
child. “It gives me hope and power for my all media sources. China’s state media that stars in the country’s professional
life,” he says. regulator issued four ‘do nots’ to producers, leagues must have “no visible ink.” The
As they have become more fashionable, including the prescription: “absolutely do issue captured global attention during
tattoos have also become a sign of privilege not use actors with stains, scandals and an under-23 friendly between China and
for young Chinese, and even more so for problematic moral integrity.” Wales in March, when members of the
those who can afford a high-quality piece Rappers were singled out in particular. Chinese team took to the field in skin-
by Zhuo. PG One, the heavily-tattooed star of colored bandages and tights hiding their
“Tattoos are now a way for the younger hit reality TV show The Rap of China, tattoos.
generations to display their wealth,” says disappeared from screens almost completely So far, the reaction of China’s
Zhuo. “Just as you buy Gucci or fake for several months, only making a low-key millennials who like tattoos has been one of
Gucci, in tattooing you can get expensive, comeback in April. frustration. After the Sina announcement,
quality tattoos or cheap, lower-quality Sina, the parent company of social many Weibo users condemned the
ones.” media platform Weibo, often referred censorship. “How can a government with
to as “China’s Twitter,” also took down high culture have such childish logic?” one
Dispirited Culture content, explaining that the government netizen wrote.
But there has also been a backlash from “specifically requires that programs should Hai Xiang, the personal trainer, is
some quarters of society, which see tattoos not feature actors with tattoos [or depict] bemused by the campaign. “I really don’t
as emblematic of the rise of a “dispirited hip-hop culture, subculture and dispirited understand the point of it,” he says. “I
culture” among China’s youth. In January, culture.” think that most of the people running

66 / CKGSB Knowledge 2018


the government are just from that older,
conservative social group.”
Many tattoo artists consider the notion
that tattoos are somehow anti-social as
deeply ironic. From their point of view,
the country’s developing tattoo movement
helps young people connect with and
popularize traditional Chinese culture.
Gang has noticed that his clients are
increasingly asking for designs inspired by
traditional tales and the Chinese zodiac. He
sees the embrace of these styles by young
Chinese as a kind of “homecoming,” as
these elements have been fetishized in the
West.
“The (Asian) style popular among
Westerners comes from Japan, and this in
turn comes from traditional Chinese artistic
techniques,” says Gang. “What people
in China are seeing on celebrities and the
internet has Chinese roots.”
Nowadays, there are thousands of
tattoo shops in Shanghai and it’s
become a very competitive business
Nevertheless, the voices of concern
about tattoos are unlikely to disappear,
according to Andrew Sullivan, Director of
the China Policy Institute at the University
of Nottingham.
“As arbiter of society’s moral health,
the party-state has an increasingly intolerant
attitude toward body art,” says Sullivan.
“This is reanimating the connection
between ink and deviancy that was never
really expunged from mainstream society,
popular culture or within companies and
family.”
In fact, Sullivan suspects that the media
ban could be the start of a wider conservative
reaction as the more traditional segments
of society close ranks against all forms of
“spiritual pollution.”
“Chinese public opinion is rather
conservative,” says Sullivan. “Moves
to circumscribe individual expressions
and behaviors like recreational drugs
and promiscuity, which tattoos have
unwittingly come to symbolize, are not
unpopular outside of urban youth and
subcultures.”
Hundred Flowers
Most of the tattoo community, however, is
sanguine about the official condemnation.
Jing Xi, the blogger and self-employed
tattoo artist, expects that the government’s
moralizing will be self-defeating. “Though
a lot of older people may agree, the
crackdown may have the opposite effect
and lead young people to rebel as they
always do,” says Jing. “Either way, there
Fall 2018
Zhuo Danting
Owner
Shanghai Tattoo
will probably be more discussion and
engagement surrounding tattoos as a
result—and this will be good for business.”
In fact, many artists welcome more
government oversight of the industry, as
the mushrooming of parlors across China
has led to the spread of poor-quality work
and unsafe practices.
“Nowadays, there are thousands of
tattoo shops in Shanghai and it’s become
a very competitive business,” says Zhuo.
“In the past, we’ve had apprentices who
have left our training program and secretly
opened their own tattoo shops. These guys
have few skills and no patience, yet want to
get straight into tattooing, ruining skin for
life.”
The backlash may also prove to be a
short-term phenomenon. Though older
officials and employers continue to enforce
traditional cultural mores, a new generation
of Chinese leaders with different attitudes
is emerging.
“I’ve had clients bring their colleagues
and managers to the shop,” says Zhuo. “It
can become a social thing.”
Before she returns to work, Zhuo
tells the story of a client who is a senior
executive at a large company. “She’s been
coming here for years,” says Zhuo. “She’s
got a full back, sleeves down both arms,
neck and scalp, but her colleagues have no
idea—she covers it all up every morning
before going to the office.”
Zhuo imagines a day not so far in the
future when the senior executive’s elaborate
cover-up will no longer be necessary.
CKGSB Knowledge 2018
/ 67
China Data

Planting new seeds

The number of large-scale commercial farms in China has shot up from around
111,000 in 2009 to around 2 million last year. Only 10% of these farms grow grains,
whereas 52% of non-commercial farms did so, according to a recent survey.
Source: Financial Times

The stats you need to know

Sea cucumber costs Dumping the junk food

China’s summer heatwave was particularly Sales of chewing gum, chocolate
costly for the nation’s sea cucumber and confectionary have fallen
farmers, whose losses in July surpassed 14%, 6% and 4% over the past
$1 billion. Many sea cucumbers could not two years in China as consumers
cope when water temperatures rose up to turn away from unhealthy
36 degrees. snacks. Demand for the additive
MSG has also declined over 10%.

Source: South China Morning Post Source: Financial Times

Growing weight issues

A government study has found that just over 17% of
boys and 13% of girls in the fourth grade in China are
overweight or obese. But children in China are still
healthier than in the UK, where obesity rates among
primary school pupils has surpassed 20%.
Computer contest heats up
China plans to reclaim the global lead in supercomputing by creating two
exascale supercomputers by 2020. The US overtook China as the owner of the
world’s fastest supercomputer for the first time since 2012 in June when it
unveiled Summit, a machine capable of 200 quadrillion calculations per second.

Source: Caixin, The Guardian Source: People’s Daily, Washington Post

68 / CKGSB Knowledge 2018

 Fall 2018

China’s Twitter is on fire

Unlike Twitter, Chinese
microblogging site Weibo is
going from strength to strength
with user numbers growing
strongly and profits rocketing
92% during the second quarter
thanks to booming advertising
revenues.

Source: Caixin

Closing the door

Chinese investment in
North America was
down 92% year-
on-year during
the first half of
2018 as the US
and Canadian
governments
axed deal
Macau winning big after deal
over security
Chinese casino hub Macau is set to overtake Qatar as the
concerns.
richest place on Earth by 2020, according to the IMF. The
southern Chinese city is predicted to have a per capita GDP
of $143,116 by that year.

Source: South China Morning Post

Source: Rhodium Group, Financial Times

Falling funding Ford goes into reverse

Venture capital raised by Chinese funds for early-stage investing plunged 53% Ford’s car sales in China fell 25% during
during the first half of 2018 as Beijing’s credit crackdown makes life tougher the first half of the year, with the company
for startups. blaming an outdated product line and the
US-China trade war. The automaker plans
Source: South China Morning Post to launch 50 new or redesigned models in
China by 2025.
Build, build, build
China is turning the fixed-asset investment taps back
on to shore up GDP growth. The State Council passed a
$197 billion local infrastructure spending plan in July,
which is 69% larger than last year’s plan.

Source: Caixin Source: Reuters

CKGSB Knowledge 2018

/ 69
Bookshelf
Deep Cuts
Kerry Brown picks out six books that get under the skin of modern China
Kerry Brown is Professor of Chinese Studies and Director
of the Lau China Institute, King’s College, London, and
an Associate Fellow of the Asia Pacific Programme
at Chatham House. He is the author of 18 books on
contemporary China, the most recent of which is China’s
World: The Culture of Chinese Communism and the
Secret Sources of its Power. You can see more about his
work at www.kerry-brown.co.uk.
Project on the City: Capitalism from Below: Markets
Great Leap Forward and Institutional Change in China
by Rem Koolhaas et al by Victor Nee and Sonja Opper
70 / CKGSB Knowledge 2018
MIT-based scholar Yasheng Huang is one of
the great political economists of contemporary
China. But, unlike most from his area, he knows
how to tell a story. His skeptical, evidence-
based and often very humorous analysis of
the anomalies of the current Chinese model in
Capitalism with Chinese Characteristics
is acute, accurate and often challenging. His
chapter ‘What is Wrong with Shanghai’ makes
the book worthwhile just on its own.
Jasper Becker’s City of Heavenly
Tranquillity: Beijing in the History of
China is beautifully written and a work which
deserved more profile when it was published
during the 2008 Olympics. For all its vastness,
China is a country of specific places. Becker
captures the hidden story of Beijing under all
the mammoth changes that have happened in
recent years. Elegant and elegiac.
Deep China is a fabulous work on a woefully
understudied area: the inner lives of Chinese
people, emerging from the era of high
socialism and state control after 1978 to a place
becoming more hybrid, and more confusing,
by the day. The writing by Arthur Kleinman
and his colleagues is superb, stimulating and a
real eye opener on the psychology of modern
Chinese living under market socialism.
Francoise Jullien offers a short, magisterial
and endlessly stimulating account of classical
Chinese and the root differences between
Chinese and Western intellectual worlds in
A Treatise on Efficacy: Between Western
and Chinese Thinking. It is a book full of
insight and wisdom, which manages with great
credibility to make the complex understandable,
and to intelligently address one of the most
vexed, and vexatious, of issues.
 Join Us For A Unique Executive
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