Chinese Government Policy is Not Top-Down

I highly recommend China watchers read this paper by political scientist Lee Jones and Zeng Jinhan. It provides a great look into how Chinese policy is implemented:

Foreign-policy steering happens through several important mechanisms. The first is top leaders’ major speeches, which are usually kept vague to accommodate diverse interests and agendas. Rather than ‘carefully-worked out grand strategies’, they are typically ‘platitudes, slogans, catchphrases, and generalities’, offering ‘atmospheric guidance’ that others must then interpret and implement. Examples include: Deng’s tao guang yang hui, whose meaning is ‘debateable’; Hu’s ‘harmonious world’ – ‘more of a narrative than a grand strategy’; and Xi’s ‘new type of great power relations.’ As discussed below, Xi’s vague 2013 remarks on the ‘silk road economic belt’ (SREB) and ‘maritime silk road’ (MSR) exemplify this tendency. [2]

Xi Jinping thought and Xi Jinping thought-study for communist cadre revolves around applying platitudes to local practice, matching national talking points to local policy initiatives. \Xi Jinping’s Speeches are completely devoid of any significant meaning, but local governments go to great lengths to mirror Xi’s  lexicon. Take the Belt and Road initiative for example.

Xi Book

Disturbing quote from Mark Zuckerberg

The Belt and Road initiative is not driven by Beijing. Provincial governments and local governments have been tasked to create their own BRI projects.

From Lee and Zeng:

In 2013, Guangxi and affiliated business interests agreed  with  Malaysia’s Pahang state  government  to  upgrade  Kuantan  port,  including  by  developing a cross-country railway, road links and a US$3.4 billion industrial park. Guangxi subsequently leveraged  BRI  to  expand  its  involvement.  However,  in  September  2015, Guangdong province  signed  a  rival  agreement  with  Malaysia’s  Malacca  state,  including  a  US$4.6 billion industrial park and a US$10 billion port upgrade.

There is little economic rationale for developing two world-class ports on the Malay Peninsula. These projects reflect not a coherent master plan but  rather competitive, sub-national  dynamics in both countries.  Moreover, these micro-level dynamics clearly do not–indeed, cannot–add up to a coherent, macro-level network of infrastructure. Unsurprisingly, statistical analysis reveals no correlation between Vision and Actions [the official policy document guiding the BRI] six ‘corridors’ and projects on the ground, suggesting that the plan is failing even to guide investment activity in a broad sense.

Foreign policy has an excellent article which, among other things, quotes how the World Bank lauded Turkey’s Marmaray rail tunnel as an example of BRI investment, ” even though it is funded by a Turkey-EU-Japan consortium and appears to have no Chinese involvement.” BRI is less of a national strategy and more of an expansion of a specific part of China’s domestic political economy: local governments borrowing endlessly to fund infrastructure projects.

The thing is, local provinces are agile in aligning to federal programs to push their own initiatives. Again citing Lee and Zeng:

Only 14 provinces were invited to the NDRC’s initial OBOR symposium in December 2013, indicating a relatively tight circle of beneficiaries. Excluded provinces, however, quickly lobbied for inclusion, through  forums  like the NPC. Provincial  universities  and  think  tanks  were  encouraged to demonstrate locales’ historical links to the ancient silk road – generating the aforementioned publications boom. Local media were also enlisted, leading to a profusion of stories mentioning OBOR, from 543 in 2014 to 5935 in 2015, with coverage in virtually every provincial outlet. For example, Shaanxi and Henan provinces waged an intense public battle over which of them contained the start of the historical silk road Competition over the MSR’s ‘starting point’ was even fiercer, with rival claims from Fujian, Jiangsu, Guangdong and Guangxi. Provinces with weaker claims invented ‘starting points’ linked to geographical locations or commodities, like porcelain or tea, then even squabbled over these. Shandong and Hebei, for example, both claimed that their cities, Qingdao and Huanghua, were the ‘northern starting point.’

China is built from the bottom up, from province to federal government. Local media, local SOEs, and local projects are cooked to align to federal buzzwords. Even SOE structure is province-up. Look at CRRC’s subsidiaries pictured below.

CRRC subsidiaries

CRRC is an active holding company comprised of many local companies. These local companies are unique in leadership, future plans, and corporate action. They shape the national SOE, CRRC.

In April of 2015, Xi Jinping declared that China will have a ‘toilet revolution’ (厕所革命). Much of the commentary and media coverage have struck a bemused tone and offered little analysis. China’s toilet revolution is a prism through which to examine how the central government takes account of popular opinion, how bureaucratic interests are championed by China’s top leaders, and how agencies can effectively implement national policy campaigns. The architect of China’s toilet revolution is Li Jinzao, former head of the National Tourism Agency. From 1998 to 2002 he served as mayor of Guilin, where he launched a local ‘toilet revolution’ to increase tourism. In 2000, his city built more than 849 new ‘tourism toilets.’

This is serious business. As head of the NTA in 2014, he designated April 1st as China Toilet Revolution Advancement Day and instituted an annual National Toilet Revolution Meeting on the first workday after the Spring Festival holiday. After catching the eye of Xi, the program went viral.

According to state media, between 2015 and 2017 the NTA was able to get the Ministry of Finance to allocate almost 1.8 billion yuan ($264 million) to subsidize toilet construction, funding which helped spur localities to invest a further 20 billion yuan ($2.9 billion) of their own budgets into toilets over the same period. In November 2017, the NTA declared that 68,000 toilets had already been constructed or upgraded, exceeding its original target by nearly 20%. Consequently, the NTA announced a “New Three-Year Action Plan” that raised its original target of 57,000 to 64,000 new or upgraded toilets by 2020.

The take away here is that localities were quick to jump on a national project with serious merit and invested more than ten times what the ministry of finance allocated.

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My photo taken at Tsinghua University. 向前一小步, 文明一大步 (advance one small step, culture/society advances one big step). It is a sign near a urinal telling men to urinate cleanly for the “rejuvenation of the nation.”Really: link

Chinese grand-strategy, from One Belt One Road and SOE structure to the massive amount of money spent on the toilet revolution, is almost always a post-hoc narrative that provinces use to justify their idiosyncratic tendencies and desires. Xi and China aren’t as centralized as commonly thought of.

Certainties From Tsinghua: $3 Lunch and Evidence Donald Trump Won’t Secure a Meaningful Trade Deal with China.

When I was a student at Tsinghua, I remember constantly complaining about the cafeteria food. In general, I struggled getting the amount of protein I needed, and a  lot of the food was oily. Picking which vegetables to eat was always difficult, because so many of them seemed to just soak in salty, oily brine.

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Campus has a number of cafeterias; this one was my favorite. Each floor has perhaps 10 stalls, and each stall on a floor is loosely affiliated with one style/region of food. This cafeteria was my favorite because the fourth floor is devoted to Sichuan cuisine.

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热饮冷饮 – Hot Beverages and Cold Beverages 西式面- Western Style Bread

Although I consistently fretted over protein and oily vegetables, the food was good and -perhaps most importantly- cheap. Here are examples of what I ate:

 

I spent an average of RMB 20 per meal (something akin to $3).  I’m certain that this is the best cafeteria food that one can buy for $3.

Tsinghua also taught me another certainty: Donald Trump is set for failure regarding the coming trade deal with China. Let me show you:

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Consumption-led growth. The decisive role of the market. Tsinghua has an amazing library. I was floored that there were so many books in foreign languages (the English selection is enormous).  I was also floored to see that many Chinese think-tank publications on economic reform were translated into English. I devoured them, nodding my head in agreement and proud at the tough policy recommendations they made: transfer state wealth to Chinese people in order to have a balanced economy.

The Chinese economic model is built upon transferring wealth from households, consumers, and savers to corporations, producers, and investors. This is best seen in China’s comically low household consumption rate.

consumption-china

As China’s economic model has progressed, Chinese households have enjoyed an increasingly small share of the nation’s wealth. Corporations, both ‘private’ and state-owned, have enjoyed an increasingly large share of the nation’s wealth (as has the richest in China). This ‘problem’ has been on the Chinese government’s radar since at least 2007.

In 2007 Premier Wen Jiabo cautioned, “”the biggest problem with China’s economy is that the growth is unstable, unbalanced, uncoordinated, and unsustainable.” This prompted IMF economists to write, in 2007, about strategies to have consumers share a larger percentage of national wealth.

However, economic reform wasn’t planned until Chairman Xi Jinping took over in 2013. Economic reform plans were immediately organized:

1.) The market had been defined as a “basic” role in allocating resources since the country decided to build a socialist market economy in 1992. In 2013, The Communist Party of China defined the market’s role as “decisive” in allocating resources. This importance cannot be underestimated.

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It is common for state-owned enterprises to have pictures to pay homage to Chairman Xi in their lobby (Forgive the poor quality).

2.) On November 12, 2013 in the Third Plenary Session of the 18th CPC Central Committee, Chairman Xi said the following regarding China’s economic reform:

The key to establishing a sound socialist market economy lies in striking proper balance between the role of the government and that of the market, so that the market can play a decisive role in allocating resources and the government can play its own role more effectively… Letting the market play a decisive role in allocating resources will mainly require economic reforms, but it will also inevitable affect politics, culture, society, ecological progress, and Party building.

3.) On April 8, 2013 at the Boao Forum for Asia Annual Conference, Chairman Xi said the following regarding China’s economic reform:

We will continue to enhance the rule of law and actively improve our investment environment so that all enterprises can enjoy equal access to the factors of production, market competition, legal protection. The Chinese market can become fairer and even more attractive… China will never close it’s door to the outside world… We will open up new areas and enable deeper access… We firmly oppose protectionism in any form, and we are willing and ready to solve economic and trade differences with other countries through consultation.

4.) On May 26th, 2014 at the 15th Group Study Session of the Political Bureau of the 18th CPC Centeral Committee, Chairman Xi said the following regarding China’s economic reform:

We should reduce the government’s involvement in resource allocation and its direct interference in microeconomic activities. We should step up efforts to develop a uniform market system characterized by openness and orderly competition, and set fair, open, and transparent market rules.

Xi in Davos

5.) In 2017 at the World Economic Forum in Davos, Chairman Xi said the following regarding ‘free trade:’

Whether you like it or not, the global economy is the big ocean that you cannot escape from. Any attempt to cut off the flow of capital, technologies, products, industries, and people between economies, and channel the waters in the ocean back into isolated lakes and creeks, is simply not possible.

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These books which I vociferously read at Tsinghua are remnants, relics of this forgone economic reform. Chairman Xi’s economic reforms, as I have been writing about for the past two years, have been complete failure. China is backtracking on reform, encouraging state-backed growth, reducing competition, and exacerbating the economic slowdown already underway. According to Ruchir Sharma at Morgan Stanley Investment Management, it now takes $3 of debt to create a dollar of growth in China. In the face of economic reform failure, China is pumping debt into large state-backed corporates while the private sector is squeezed out.

A Chinese dictator tried to force reform. That reform failed.

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The United States is seeking the following changes in the Chinese economy: trade deficit reduction, IP protection, cease market distorting subsidies, end of cyber intrusions, and end technology transfer.

The idea that the United States would be able to force large, structural reform in China when a Chinese dictator could not is absolutely ridiculous. The idea that Beijing is unable to move on the US requests, most made 9 months or even years ago (IP Protection), and that another 60 days will be enough time for them, seems somehow more ridiculous.  The hubris of the United States position is overwhelming. The Xi speeches, the policy reports from think tanks, these are fossils of failure that the United States should heed.

tweet 1

CNBC is also reporting that President Donald Trump said he will be discussing the criminal charges against Huawei with US attorneys and attorney general in the coming weeks. Is the United States judiciary no longer independent? If the United States accepts a trade deal that backs Chinese purchases of US goods to reduce the trade deficit, America is run by a spineless swamp with no sense of the lack of economic freedoms that put the US in this position to begin with.

The White House would do well to look at Chinese economic planning relics from 2013 or read Chairman Xi’s speeches.

Thanks for reading.

 

Huawei and A Bifurcated Tech Future

I thought more than I would like to admit about how I could fit the following phrase into this blog post:

It’s my way or the Huawei.

And with that off my chest, lets get to today’s topic: the near future of tech.

Any definition of emergent technology should include the following: information technology, robotics, green energy and vehicles, aerospace equipment, oceanic engineering, new materials, medicine, medical devices, agri-tech. Very conveniently, these are the sectors explicitly slated to gain state support in China under Made In China 2025.

made-in-china-2025-supchina-explainer

Crucial to emergent technology is infrastructure to move vast amounts of data and information. Only a few telecommunications companies are positioned to provide the complex solutions these new industries demand. 5G (telecommunication networks), mobile devices, and global services are necessary is securing the success of emergent technology.

Luckily for the world, China’s Huawei is positioned to provide such solutions.

The Pride of China

I studied Chinese at Tsinghua University. The view from my chair was that of a large blackboard. 20180403_113153

Note the camera on the top left. There was also a camera in the back of the room. 

Sitting to my left in one of my classes was a young Swiss man. On a Friday morning, he told his language partners that he was in the market for a new phone. On Monday morning he walked into class with a new Huawei phone. My teacher, a brilliant young graduate student at the neighboring Beijing Language University (北京语言大学), was floored.

“Why didn’t you buy an iPhone?” she asked.

He replied, “Huawei phones are much cheaper and just as good. I don’t like iOS anyway.”

“As a Chinese, I am so proud. Huawei is the pride of China,” She beamed.

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The ‘pride of China’ should be its food. This was a normal lunch at Tsinghua. It was delicious.

She was right. National champions, large companies that enjoy massive amounts of state subsidies and are protected from competition, are a distinct part of the national identity. Apple is not a competitor. Apple is America. Huawei is China.

Huawei is China

So lets expand on Huawei. Their Wikipedia page is absolutely fascinating:

Wiki capture

A warning about buzzwords and advertising? The following quote is worth thinking about. From Huawei’s Wikipedia:

Although successful internationally, Huawei has faced difficulties in some markets, due to allegations – particularly from the United States government – that its telecom infrastructure equipment may contain backdoors that could enable unauthorised surveillance by the Chinese government and the People’s Liberation Army (citing, in particular, its founder having previously worked for the Army).

Huawei has faced difficulties in some markets, due to allegations- particularly from the United States government. Does this hold water? Let me list some links.

Huawei blocked from bids in England.

Germany is drafting new rules for how to deal with Huawei.

Norway’s PST warns against Huawei.

The Czech Republic’s cyber security agency reports that Huawei is a national security threat. (This is particularly worth following because China has invested heavily into the Czech Republic, and Huawei has had a contract to fulfill the communication needs of the president and his staff for the past four years.)

Lithuanian intelligence reports that Huawei is an intelligence arm of China.

Rumors in Italy of banning Huawei from 5G infrastructure are ongoing.

Last month in Poland, a Huawei employee was arrested as spy for China. Huawei has responded by offering to build a cyber security center in Poland.

FBI raids Huawei’s San Diego Office.

It is certainly true that the United States was early in its concern of Chinese (Huawei) infrastructure investments. However, to say now that concern is solely or mostly propagated by America is dishonest.

Bifurcated Tech

I said something to this point relatively recently on China Unscripted (episode 20): there is a growing Cold War between China and America. That Cold War is not being waged in proxy wars or through arms races. The new Cold War is being waged through a race to emergent tech, economics, and business access.

The truth about Huawei is pretty simple. If the new Cold War is being fought in emergent tech, Huawei is going to play a key role. It is an arm of the Chinese Communist Party.

Huawei Capture

Examples of communist control include the following:

1.) Huawei has a party secretary. Party control of Huawei is explicit. Its in their Wikipedia page.

2.) Huawei enjoys lending at the direction of Central Huijin.

3.) Huawei enjoys price setting and input discounts from the NDRC.

Given these facts, it is almost intuitive that Developed countries decouple from Huawei and Chinese tech in general. What we are witnessing across Europe, North America, and Australia is decoupling at a time when Africa, South East Asia, Russia, and the Middle East are increasingly embracing Chinese tech. We are witnessing a technological divide. With that tech divide, we are seeing a divergence in public opinion and thought.

Consider Chairman Xi’s recent trip to visit the new media operation of People’s Daily, the party’s mouthpiece. He spoke at length on the importance of “boosting integrated media development and amplifying the mainstream voice” in public communication. Mainstream voice indeed.  The mainstream voice seems to be Xi’s way or the Huawei.

(Nailed it).

Thanks for reading.

 

 

What Caused The Great Recession

Savings, Investment, and My Worldview

Riemann Surfaces are pretty neat. Frankly speaking, anything with complex numbers – sometimes referred to as imaginary numbers- is just cool. I think there is just something intrinsically pleasing when they are modeled.

riemann surfaceCool, right?

Economics, like Math, has many tools . This blog has tended to use one or two tools when addressing China and Chinese trade policy. The most noteworthy of which is the following:

(M – X)   =   (I – S) +   (G – T)

Don’t panic. The function above states that a trade deficit (imports-M- less exports-X) is equal to the savings deficit (investment-I- less saving-S) plus the government’s fiscal deficit (government spending-G- less its tax revenue-T).

This blog has consistently talked about policies that influence national investment, savings, and consumption rates, because that is a key tool for how I understand China. Consider the picture below:

jinanxi station

My first corporate training with DuPont Pioneer actually took place in Shandong Province.  I took a bullet train from Beijing to Jinan (Google Maps link) to train Pioneer staff. The picture above is one of Jinan’s railway stations. I was awestruck by how large it was. I was awestruck by how empty it was.

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In China you return tickets to your company in order to get reimbursed for travel expenses. I wish I could have kept all of my train tickets. Thanks to DuPont for the first class travel.

One could look at the empty infrastructure in Jinan and see wasted money (NY Times link – Good read), but I believe a better mental exercise is to determine what it says about the relative power of different parts of the economy. China and its state banks deploy large swaths of capital to local infrastructure projects, so China’s investment rates are quite high. Investment rates are so high because of a set of policies that force money from savers and consumers to investors and producers: environmental degradation, artificially low interest rates, tariffs, and state owned enterprises – to include banks. This means that Chinese people receive a smaller portion of GDP so household consumption is low and savings are high. If there are 4 sectors to an economy- normal households, wealthy households, businesses, and governments- we can observe the ratios of investment, savings, and consumption to paint a story about who is benefiting in a given economy.

This ratio of investment and savings also fits into trade. I have previously written about how domestic policies – like tariffs – affect the balance of investment and savings in an economy and can impact foreign trading partners. This reasoning- domestic imbalances leading to foreign trade friction- has been a theme of my blog. It greatly contributes to my worldview.

Tsinghua University and What Caused The Great Recession

pierce at tsinghua

I was blessed to study at Tsinghua University (清华大学). At Tsinghua I, unsurprisingly, found myself attending meetings with the Tsinghua Economics Club. It was there that I inevitably talked to my Chinese peers about the real economy and how China’s domestic imbalances affected America. China, I contended, was unfair.

My thoughts were met with poignant questions: is there a link between the real economy, trade imbalances, and East Asian capital account surpluses with America’s financial stress and the Great Recession?

I found the answer from BIS, the Bank for International Settlements. Consider the following pictures that show trade flows and banking flows.

china banking flowschina trade flows

What imploded in 2007-2008 were not Sino-American financial relations, but the interlocking claims between American and European banks. I’ve written about this previously. My favorite math, my worldview based on investment and savings rates, was lacking when confronted by questions at Tsinghua.

gross capital flows Discussions at Tsinghua taught me that gross capital account flows matter. They matter a lot. In 2007-2008 Europe’s banks were at least if not more dangerous than their American counterparts. They straddled three giant credit bubbles: in the US, in the hot spots of the Eurozone, and in Eastern Europe. Their leverage was enormous, their capital laughably thin, and unlike their US counterparts they had considerable currency mismatch on their balance sheets. They needed to raise dollars to hold huge portfolios of America subprime. Their primary home funding sources were in European currencies.

european leverage

European banks went to great lengths to underwrite mortgage backed securities. Did you know that from 1997 to 2007 it was not an American bank that was the top underwriter for MBSs?

underwriters of mbs

Furthermore, we can clearly observe European banks changing safe assets to short-term, speculative assets in a different currency.

european changing investment

When emerging markets like China acquired US safe assets, they crowded out other investors and created the opportunity for private financial engineers to launch the securitization boom. The industry generated a new, private source of safe assets. European banks bought into short term gross flows (both in and out) while comically leveraged. In fact, the earliest sign of coming collapse was Paribas’s announcement in 2007 that it was closing its US real estate funds, for lack of liquidity in the market. Following as it did on the difficulties of several smaller German banks, one might think of this as a moment of European crisis.

So, again, what caused the Great Recession? It is worth repeating. Emerging markets like China acquired US safe assets, crowding out other investors and creating the opportunity for financial engineers to launch the securitization boom. The industry generated a new, private source of safe assets. European banks poured money into America to shuffle assets into MBSs. A European banking glut was a crucial – if not the crucial- driver.

There exists different rule sets for different economic segments. In 2008 central bank liquidity swap lines were deployed within a familiar trans-Atlantic frame. The swap lines still mapped the contours of the cold war and world war II. On the new frontier of the global economy none of that soft tissue is present- Russia, India, and China still have no swap lines. Rule set mismatches are always friction points. I see less-and-less global savings-glut imbalances, while I increasingly see global rule set imbalances. I am pessimistic about our ability to resolve these discrepancies.

BIS study links (all worth reading):

Tracking the International Footprint of Global Firms

Global imbalances and the financial crisis: link or no link?

A key currency view of global imbalances

My favorite studies on the Banking Glut:

Global Banking Glut and Loan Risk Premium

ABS Inflows to the United States and the Global Financial Crisis

 

China, Bicycles, and Culture

I love Macro Polo. I read it regularly and urge anyone with a passing interest in China to give it a browse. I also love Macro Polo’s most recent post  about bikes in China. The love I have for the post is deep, because in the recesses of my heart exists a counterweight of hate for bicycles in Beijing. The almost romantic whirl of millions of wheel spokes captures many visitor’s hearts. The cursing of average commuters funneled into artificially narrow sidewalks induces PTSD for others.

I loved my bike in China. I loved that the back brakes didn’t work. I loved joining a throng of pedestrians and motorists with one governing rule: there are no rules. The secret to appreciating a foreign culture is to live as they do: eat their food, speak their language, and hurl concise insults at motorists you play chicken with.  My bike wasn’t just a way to drastically shorten my commute (leave it locked near your subway exit of choice), it was a quintessential manifestation of modern China, good and bad.

I have roughly 4,000 pictures of my time in Asia. One of the first folders I created is simply titled ‘bikes.’  These are my favorites.

Shared bikes in Beijing’s CBD clog sidewalks. Rush hour pedestrian traffic is greatly constrained due to this.

Users can pay more for ‘cooler’ bikes. Note the width of the tires in the second photo.

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Bikes can be found everywhere due to an army of shirtless men that deposit bikes (bikes are equipped with GPS) in high traffic areas.

Bikes can be found in crosswalks. Note the couple struggling to make their way across.

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Bikes can be found in rivers.

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Bikes can be found in piles.

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Most importantly, bikes can be found clogging sidewalks.

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There are many types of bikes. Pictured above are university bikes (清华大学).

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Bikes pulled by dogs.

Unwanted Bikes

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Really unwanted bikes.

In France in the 1880s, the cheapest model of bicycle listed in catalogs and sales brochures cost the equivalent of six months of the average worker’s wage. And this was a relatively rudimentary bicycle, “which had wheels covered with just a strip of solid rubber and only one brake that pressed directly against the front rim.” Technological progress made it possible to reduce the price to one month’s wage by 1910. Progress continued, and by the 1960s one could buy a quality bicycle inFrance for less than a week’s average wage. One can use bikes in France to see how purchasing power rose by a factor of 40 between 1890 and 1970.  Transportation, whether by Toyota or trike, matters.

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Thanks for reading.