China and Soft Protectionism

In the Hutong
What, cold again?
2142 hrs.

Protest in Hong-Kong against WTO on december 2005
(Photo credit: Wikipedia)

Though we may not be talking about it much, those of us who watch China for a living are looking forward with a mixture of dread and anticipation to the upcoming “two meetings,” the annual sessions of the National People’s Congress and the China People’s Political Consultative Committee. Even though the die of China’s future leadership was cast at the Party Congress in November, the coming NPC is the juncture where the reins of government are handed over to the new leadership, and the retiring members of the Hu Jintao/Wen Jiabao entourage graduate to the status of “elder statesmen.” For that reason, this is the point at which we will all be watching for some indication of how Xi Jinping and Li Keqiang will run the show a little differently.

While some will be looking for signs of political reform, my eyes will be cast elsewhere, namely to trade. What I want to find out is whether and how the new administration plans to play by the rules it signed up for when it acceeded to the WTO eleven years ago. Or, indeed, how it intends not to do so.

Since at least the early days of the Hu Jintao administration it was clear that the so-called Fourth Generation of leaders was somewhat less enthusiastic about playing the globalization game, and much more interested in just keeping a lid on the place. Stability was the name of the game, and the spirit of we-can-take-whatever-free-trade-can-dish-out that exuded from Zhu Rongji like a heavy cologne was blown out the window when Zhu left the building in 2003. In its place came a series of policies that I term collectively “Soft Protectionism (软保护主义),” a series of measures and behaviors that allow China to circumvent the intent of the global free trade regime almost at will.

Soft Protectionism, as I see it, consists of several pieces.

National Standards. We see this most blatantly when it comes to technology. The government establishes a standard based on a technology that is locally developed, and by so doing secures all or at least part of the market for Chinese output. The TD-SCDMA standard for third-generation mobile phones is a great example, as is the WAPI wireless LAN standard that was supposed to supplant Wi-Fi. China has learned that this policy is best conducted when it is done within the parameters of global standards-making bodies like the International Telecommunications Union (ITU) and the Institute for Electrical and Electronic Engineers (IEEE.) Through organizational activism, horse-trading, and the occasional theatrical tantrum, China is able to gain acceptance for standards that are, in some cases, little more than laboratory experiments. Using this global legitimacy, the standards ploy becomes legitimate. And lest you accuse me of being biased, let me make clear that we Americans all but invented this game, and we perfected it with our bull-headed nationalist behavior when it came to standards for digital televisions and the first digital phones. China is simply turning the tables.

Creative Use of Non-Tariff Barriers. Despite the openness promulgated by the WTO, there are still back doors that will allow governments to selectively protect industries. The first and favorite of these is the so-called National Security Exemption from the World Trade Agreements. The key phrase is “Nothing in this Agreement shall be construed . . . (b) to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests”

That exemption gives wide latitude to any government willing to interpret it liberally, and China can and does do so, especially when it comes to information products and software. Other countries use this exemption to ensure that they have access to weapons production in the event of international isolation. The U.S. uses it, for example, to ensure its ships, tanks, and warplanes are all made by factories on US soil, but it does not use it to stop the import of foreign merchant hulls, diesel trucks, or civil aircraft. China, according to Nathaniel Ahrens at the Center for Strategic and International Studies, is comfortable crossing that line.

China also manages to restrict the free trade in publications, television, film, and music by stretching the WTO’s Cultural exemption (introduced by France in 1993) beyond the breaking point. Under the guise of protecting its vulnerable culture, China requires specific approval for any publication, recording, video, or film coming into the country. Keep in mind that we are talking about the culture that for nearly two thousand years has managed to assimilate every culture and nation that tried to subjugate it. Nonetheless, the exemption is used at every juncture.

Passive resistance to WTO Rulings. Rather than submit to WTO rulings it does not like, China conducts a passive-aggressive policy of resistance, even at the risk of undermining the institution. Dan Harris of China Law Blog fame put it like this:

“China still intends to remain within the WTO so as to be able to obtain certain trade benefits. Rather than openly disregard the minerals decision, China will resort to “procedural games” (游戏规则) to render any response against China ineffective as a practical matter. China is proud of how it has  used “procedural games” to avoid its responsibilities to respond to adverse WTO decisions and it openly states that it will continue to use this approach in these “national interest” cases. In fact, the term “procedural game” has become a standard feature of the China’s trade policy vocabulary.”

Government Catch-up initiatives. These are the micro-level great leaps that the government attempts to engineer over time in order to substitute domestically-made products and technology for locally-made equivalents. The past thirty years has seen China-government sponsored initiatives succeed in “catching up” in several industries, including shipbuilding, digital telephone switches, heavy trucks, wind-power generators, and solar power, and it is attempting to do so in automobiles, commmercial aircraft, microprocessors, and encryption software. The end result is the same: serviceable and appropriate products from overseas are gradually pushed out by government programs designed to deny them access to the market.

Government encouraged SOE support. This comes in many forms, but the most prevalent is outright cash payments. By offering low-interest or permanently rolled-over loans for state owned enterprises through state-managed policy banks at either the national or local level, China creates effective trade subsidies that are not counted according to international standards. A senior Obama administration official confided in me on the sidelines of the Strategic Economic Dialogue in Beijing last year that China’s export loans dwarfed even the U.S.’s generous programs through the Export Import Bank.

There is not much that the US, the EU, or any grouping of governments can do about any of this, short of an all-out trade war, if China chooses to continue with these policies. What this means is that even as a full-fleged WTO member, China is still capable of providing a protected environment for its firms, and has proven willing to do so.

Such policies will help companies beat foreign interlopers at home, but at what cost? At some point China will confront the other edge of that sword, whether in the form of having its behavior mirrored by other countries with tit-for-tat trade measures within the scope of the WTO; or by discovering that the companies it protected at home were weak and unprepared when venturing abroad.

For Xi Jinping, the choice in the coming months is whether to continue to use Soft Protectionism as the nation’s de-facto trade policy, or whether he will instead switch off the pumps and force Chinese companies to build the resilience necessary to beat global competition away from home. For the companies themselves, as Sunzi said, “Enemies strengthen. Allies weaken.” The wise Chinese company will seek to step out from under Beijing’s umbrella as early as possible to learn to compete on a globalized playing field, rather than a nationalized one.

Luxury Cars: The Non-China Chinese Market

Lamborghini & Ferraris
Lamborghini & Ferraris (Photo credit: Axion23)

In the Hutong
Work Break
1945 hrs.

On Valentine’s Day, the always excellent Jing Daily published an article (“Ultra-Luxury Auto Sales In China Surprisingly Robust, But Are They Sustainable?“) that calls into question whether those stunning new Lotus, Maserati, Bentley, and Ferrari dealerships that are sprouting up around China are in for some hard times. Economic uncertainty and the potential that Xi Jinping‘s administration might discourage conspicuous consumption apparently has many buyers holding off on purchases. The spectacular Beijing accident a year ago that claimed the son of a powerful Party official and one of his passengers has made ultra-luxury cars an unintentional symbol of cosseted elites and official malfeasance. Markers of success are becoming stigmata of excess.

But the Chinese party is not over for the luxury car-makers, although a change in strategy may be in the offing. It may be time for the Ferraris and Bugattis of the world to learn from the purveyors of less expensive luxury goods, because the real market may not be in China: there is a fair chance that the majority of Chinese who will be buying ultra-luxury cars in the future will be buying them overseas.

Naturally they won’t be doing so in order to ship the cars back to the PRC (with the exception of the occasional gray-market beast that cannot be found in China or Hong Kong). Instead, they will be buying their high-speed bling to park them in the garages and and driveways of the homes they are buying in North America, Europe, and Australia.

Adjusting to this shift will mean changes in the way these cars are sold outside of China. Dealerships will need Chinese speakers on the showroom floor and in the service bays. Sales literature and owners manuals will need to be available in Chinese as well as the local language. Manufacturers will need to create Chinese websites for markets where Chinese isn’t usually spoken. And that is just a starter list.

The really smart manufacturers will set up Chinese-language customer service hotlines and owners clubs that cater to Chinese speakers in North America and Europe at least. They will advertise online in Chinese and in the mass media of the Chinese diaspora. And if they’re really smart, they’ll offer those special models and features that are designed to cater to the tastes of the new global Chinese elite.

None of this is mandatory, of course. For some brands, the snob appeal is derived in part by the derision with which it treats even its best-heeled customers. But the wiser luxury car manufacturers will realize that the Chinese are coming to the world: best to reach out and meet them before they decamp to the competition – or decide to spend their money on something else.

Luxury Goods: Meet the Experience Hunters

Rodeo Drive in Beverly Hills
Rodeo Drive in Beverly Hills (Photo credit: Wikipedia)

In the Hutong
Warming-up a little
1453 hrs.

The Chinese New Year holiday is a period where many of China’s well-heeled consumers travel abroad, so it was no surprise that CCTV ran a story on how many Chinese consumers use their trips not just for sightseeing and relaxation, but for buying luxury goods. The national broadcaster took China’s 80 million international travelers to task for spending $30 billion abroad last year buying luxury goods, and criticizing them for not spending that money at home.

Laurie Burkitt at The Wall Street Journal picked up the story, noting that Chinese duties raise the price of Rolex watches, Gucci shoes and Louis Vuitton purses between 30% and 50%. One can see why the government is concerned: that’s somewhere between $9 billion and $15 billion in lost import duties, plus the lost value of rents, income taxes for shop workers, etc. The brands are starting to realize where the bread is landing: Gucci is apparently halting all domestic Chinese expansion plans.

Luxury is an Experience, not a Purse

The media coverage of this transnational luxury buying spree implies that a hunt for bargains is all that sends these buyers abroad. Yet while price is doubtless an important motivator, there is more to it. What most analysts – and probably a few brands – are missing is the unarticulated value luxury consumers place on the experience, those intangible factors that makes buying the purse, the shoes, the watch, the dress so deeply satisfying.

One factor for Chinese in particular is mental comfort. It is not much fun consuming conspicuously in an environment that heaps growing opprobrium on bling buyers. Better to go somewhere where your purchase is at least taken in stride, if not celebrated. These days, that means buying in Hong Kong, Tokyo, Singapore, New York, Beverly Hills, London, Paris, or Milan – not Beijing or Shanghai.

But there are other factors that make up the luxury buying experience, factors captured in such post-buying questions as:

  • Where did I buy this?
  • What was the service like?
  • Did the salespeople make me feel at home?
  • Why was the experience special?
  • What was different  about buying there than in China?
  • What was I able to get there that I couldn’t in China…or anywhere else?

Any and all of these factors have the potential add greater meaning to the purchase, make its acquisition more gratifying, and deepen the relationship with the brand. Equally important, they add to the “show-off” or “shai” value of the item. The new owner not only gets to show-off the bauble to her friends, she also gets an excuse to relate the trip, the circumstances, and the feelings she took from the purchase process itself, all to the admiration (or envy) of the people whose respect is important to her.

Some Brands Get It

On a vacation trip in 2008, my wife bought a limited-edition LeSportsac Tokidoki handbag designed by Simone Legno at the LeSportsac store on Waikiki. The store was a delight, the location superb, the service was so good that even my son and I felt good about coming into the store, and that is saying something. My wife had never heard of Tokidoki  before, but the whole experience of buying the bag was such a delight that she came back the next day to buy one for her mom. To this day, five years later, she still talks about the bag, and has a deep affinity for LeSportsac.

Christine Lu of Affinity China is out ahead of the industry. She has begun leading luxury shopping tours of the U.S. for Chinese ladies that go beyond high-end store-hopping. Shops on Rodeo Drive, Park Avenue, and Waikiki are prepared in advance, provide engraved invitations, put on private fashion shows with Chinese narration, serve champagne and chocolates, and arrange to have purchases taken back to hotels while the ladies continue their day. As a bonus, Christine will bring along a Chinese celebrity or two, and tweet/blog/weibo aggressively, raising the profile of the trip and making mere attendance prestigious. The stores who work with her get it: the experience is every bit as important as the quality or design of the items that go in the bag. Expect these kinds of events to grow into a trend, traveling trunk shows where the groups come to the stores.

So all of this is interesting to be sure. Here is why it is important.

Today, it’s Price, but Tomorrow it Won’t Be

Understanding the non-price factors that drive Chinese to buy abroad is going to grow in importance. At some point the Chinese government will figure out that it needs to take steps to keep the luxury dollar at home beyond lame propaganda campaigns to shame buyers as unpatriotic. That will mean eliminating the price difference for buying at home. Either the government will have to start levying duties at airports and ports of entry (insanely hard to do and guaranteed to cause congestion at China’s overwhelmed airports and borders,) or they will need to eliminate duties altogether.

It is anyone’s guess on which course Beijing chooses, economic logic notwithstanding. When that happens, luxury brands will have their own choice to make: they can either play the zero-sum game, doing nothing and watching overseas purchases slowly leech back into China; or they can play the growth gambit, sustaining patronage overseas while building sales in China.

I’m betting the brands will want to do the latter, so I expect to see them taking steps to improve and even differentiate the buying experience for Chinese luxury consumers. At the very least, we will see more luxury stores with Chinese speakers and creating the kind of buying experiences that Affinity China is teaching them to offer.

I expect it will (or should) go beyond that. The brands will realize that simply offering a cookie-cutter experience in every store worldwide misses the point for their clientele. Each city, each store has to offer a different but equally compelling experience that reflects the brand in a unique way. This starts with store layout, but also speaks to decor, merchandise, and layout that reflects the location, and even offering items that are exclusive to that store. Let’s face it: even Disneyland has learned to differentiate its parks worldwide. Can luxury brands be far behind?

It is a truism (or should be one) that long after the price of an item is forgotten, the experience is remembered. Price will bring China’s increasingly sophisticated luxury customers in your door, but the experience will form the basis of a lasting relationship.