Two Essential Reads, Fresh Today

In the Hutong
Learning the meaning of “Wu Ti Tou Di”
1049 hrs.

While finishing my presentation on e-Commerce for Marcom Beijing, Twitter alerted me to two outstanding blog posts that are of the stop-and-think variety, and I wanted to call them out.

First is Paul Denlinger’s essay “Has China Embraced an Outdated Version of Corporate Capitalism?” in his always-entertaining, often-provoking ChinaVortex. What Paul is really asking, I think, is whether the form of corporate caplitalism China has embraced, which I would argue served China well for the first three decades, is now outdated, and dangerously so. Paul is a contrarian, to say the least, but his thoughts here demand consideration.

Second is Kevin Lee’s superb “What the Media Won’t Tell You About China’s Youth” on his genYchina blog. The media in the west, with a few notable exceptions, tend to focus on those aspects of Chinese youth that best reflect either the fears or preconceptions of their audiences. (This is understandable: as I have said here before, mainstream media are, for the most part, in the business of catering to their audiences, not challenging them.) Kevin sets some of those misconceptions straight in a forthright piece in his blog, an article that should be required reading among marketers in China.

Paul Denlinger

The big problem I’m trying to point out that China’s economy and planning are optimized for production for SOEs; they are not optimized for profitability. This worked during the consumer age in the US; now though, the US consumer is facing tough times.

If the market has turned away from mindless consumerism, does it make sense for Chinese SOEs to employ huge numbers of people without regard to profitability? Especially when the Chinese consumer, that elusive creature which the Chinese government and marketing types are endlessly talking about, is still spending at a slower growth rate than capacity and inventory is building up.
This is the kind of situation which a top-down command economy is not well-equipped to deal with.

Instead, it’s much better to let smaller private sector businesses, which are more sensitive to market changes, and which cannot turn to the government for bailouts, to step up and capture more market share, and be profitable in the process. Chinese SOEs will continue to lose money, and in the end, Chinese taxpayers will have to carry the costs for their mistakes.

David Wolf

Paul, is the problem that they are not optimized for profitability under any circumstance, or not optimized for profitability when their export markets stop growing?

Paul Denlinger

David, they worked fine while credit was readily available for Americans. During that period, low Chinese input (mainly labor) costs kept inflation under control.

But when consumer spending disappears, it doesn’t matter what your per unit costs and profitability are; unsold inventory piles up, and this cuts into operating capital. Who will cover these losses? In the case of Chinese SOEs, the government steps in.

Now, for all practical purposes, credit has disappeared. This is because while interest rates are low, Americans are fixed on repairing their own balance sheets. Put in blunt terms, Americans need to save money to get back to zero. For this reason, they have stopped buying except for necessities. Both Chinese and American consumers are signaling that they are hunkering down for hard times ahead by saving as much as they can. This is in spite of messages from their governments urging them to go out and spend.

Another bad sign is the new report of Americans taking money out of their 401Ks to cover basic expenses, even though this incurs a 10% penalty. This means that they are scraping the bottom of the barrel of their savings.

In China, we have seen pay raises to manufacturing personnel to encourage them to go and spend more of their discretionary income after they have already been forced into spending more than many can afford on overpriced residential real estate. In many cases, prices were forced up by RE developers in collusion with corrupt government officials. So the pay raises are a reimbursement for money which was taken from them by the corrupt developers and government officials. Does that make sense?

In the US, RE was used to mortgage Americans’ future. In China, it is used to clean out the savings of Chinese, who see home ownership as a necessity. By forcing up up RE prices to a high level, it makes less discretionary income available to those who can afford those prices, and it locks out from home ownership those who cannot, and creating a potential new urban underclass.

The Chinese government is obviously aware of this situation, which is why they have recently made aggressive moves to cool down the RE market.