Silicon Hutong

China and the World of Business • China Business and the World

Silicon Hutong - China and the World of Business • China Business and the World

Beijing’s New Internet Buzzphrase

Hutong Forward
Planespotting at Reagan National
1655 hrs 

In a ten minute speech last month in London at the 50th Meeting of ICANN, Lu Wei, the Minister of China’s Cyberspace Affairs Administration, introduced a set of seven principles under which, according to him, the Internet should be governed. While not much attention was paid Mr. Lu or his speech outside of the confines of the attendees, we can assume that it was an official statement of government policy, and therefore worth understanding, analyzing, and discussing.

His principles, as I heard them, are:

  1. The Internet should benefit all mankind and all of the world’s peoples, rather than cause harm;

  2. The Internet should bring peace and security to all countries, instead of becoming a channel for one country to attack another;

  3. The Internet should be more concerned with the interests of developing countries, because they are more in need of the opportunities it brings;

  4. The internet should place emphasis on the protection of citizens’ legitimate rights instead of becoming a hotbed for lawbreaking and criminal activities, let alone becoming a channel for carrying out violent terrorist attacks;

  5. The internet should be civilized and credible, instead of being full of rumors and fraud;

  6. The Internet should spread positive energy, and inherit and carry forward the outstanding culture of human beings;

  7. The Internet should be conducive to the healthy growth of young people, because that concerns the future of mankind.

There is a lot to grist in these, but what jumped out at me was this catchphrase “credible Internet.”

There is a ring to it that suggests that we are going to be hearing this much more in the coming months, but the aim seems clear. While in the past the boundaries of online expression have been defined by prurient content on the one hand and seditious content on the other, there is now a third piece to that troika: rumors.

This is worrisome: “non-credible” content implies a much wider scope for restriction than the modus vivendi we have enjoyed in the past, and opens to official censure a vast swath of online content. You can avoid posting prurient content rather easily by avoiding adult themes and illustrations. You can dodge seditious content by steering clear of domestic political issues. But “non-credible” content is in the eye of the beholder, and can easily extend to commercial content and company web sites as well as posts on Weibo or WeChat.

Watch this space, as I suspect we are going to learn more about where the authorities are going to be drawing the line. In the meantime, any company or individual producing a content-laden Chinese site or posts on Weibo or WeChat should err on the side of caution. Chinese law is unkind to those whom the authorities accuse of spreading rumors, and demonstrable veracity may not be enough to keep you out of the wrong kind of spotlight.

China Goes West: The Coming Rise of Chinese Brands

China Goes West: Everything You Need To Know About Chinese Companies Going Global
Joel Backaler
May 2014

If there is one question that vexes many observers in China, it is this: how can Chinese companies begin to build – or become – global brands? Thirty-six years after the beginning of reforming and opening, only a handful of Chinese companies – Lenovo, Huawei, Haier, Tsingtao – have made the leap to global leadership in their sectors. This invites a rude comparison: 36 years after it was flattened by the US Army Air Corps, Japan had already produced dozens of leading consumer brands – Sony, Panasonic, Toyota, Honda, Canon, Nikon – that were disrupting industries around the world. Why has China not produced a similar – or even larger – crop of world leaders in the same time frame?

In an intriguing new book, China Goes West: Everything You Need To Know About Chinese Companies Going Global, author Joel Backaler offers us a glimpse into why there are so few Chinese global brands. And some of the reasons will surprise you. I won’t spoil it for you, but the reasons go way beyond marketing competency.

Backaler, who has spent the better part of a decade studying Chinese business and is the author of a highly respected blog on the subject, was given unprecedented access to the companies and their executives, and tapped the knowledge of some of the wisest observers of Chinese companies.

Through the stories of these firms, Backaler explains what drives Chinese enterprises to even consider going global in the first place. He describes the painful path that China’s pioneering Champions followed to get there. And he leaves you wondering why, despite the potential rewards, an more than a handful of Chinese companies would bother.

But Backaler pulls no punches – he clearly believes that we are on the cusp of a major change, one that will see a rash of Chinese companies go global, and in the process disrupt global markets much the same way the Japanese did in the 1980s. You may not agree – but Backaler’s makes a persuasive case, and he makes some pointed suggestions on what the rest of us should do in response.

China Goes West is not a marketing book, but it is a book all of us must read for a simple reason: it describes how China will build global companies, and it gives us the strategic insight we are all going to need to either help them – or to help their competitors stop them.

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And Here Come the Microfilm Regulations

In the Hutong
Beijing Youth Politics College
1603 hrs

A few weeks ago, we noted that the growing phenomenon of microfilms – motion pictures produced inexpensively with digital technology and distributed online – was becoming too popular to long avoid the attention of regulators.

Now, it appears, those regulations have come. As the Associated Press notes:

This week’s update of a two-year-old regulation on the supervision of online dramas and microfilms has raised fears of stifling creativity. The broadcast administration now requires content makers to register with their real names, production companies to obtain operating licenses and report their content before it is put online, and video-hosting companies to keep records of uploaded content.

This places microfilm producers in one of two boxes: they will either be legit, or they will go guerrilla, and if they do the latter, the best avenues of distribution will be closed to them. Of all of the regulations, the last is the kicker. Video hosting companies, who thrive because the government chooses not to look too closely at whether their most popular content has been approved for broadcast, will anxious to avoid antagonizing their regulator.

Depending on how stringent the regulations are and the spirit under which they are enforced, there are two likely outcomes to these regulations: a vastly larger and more creative film industry; or the world’s largest guerrilla film market. If the government simply uses the licensing regime to turn microfilms producers into legitimate small businesses, they create a tax base and the wherewithal to fill the digital pipeline with legitimate, local entertainment. They also take a step toward turning China into the global film powerhouse the government aches to create.

At first blush, this outcome seems unlikely: why regulate if you are trying to grow an industry? In China, though, because a business license is granted for one or more specific activities, the act of regulation actually creates a channel to legitimize a business, and thus afford it the ability to operate above board. Further, if the government only requires “reporting” of content and not approval prior to posting, this alone represents a major step for filmmakers.

Even under such a regime, the government will continue order the removal of any film that steps beyond the bounds of Party propriety into forbidden topics or prurient content. That door of control remains open to them, as it is today.

If, on the other hand, the government is niggardly with microfilm licenses, or if it lays upon producers onerous approval requirements as a part of the reporting process, the result will be a community of guerrilla filmmakers and sites that distribute their works. At that point, there will be no regulating the content, and filmmakers will feel free to take on even themes that would discomfit the party.

Under a draconian implementation of these laws, distribution will not stop: it is, actually, easy to envision people sharing forbidden films via email, torrent, thumb drive or other means, from person to person, much as samizdat literature did in the Soviet Union during its final decades.

The rational choice seems to call for a robust, regulated film business that builds China’s soft power and draws its eyeballs away from foreign content. We will know within six months how this will all shake out.

Five Predictions: China’s Business Environment in 2014

Hutong West
Sunday Afternoon Countdown to Morning in Beijing
1526 hrs. 

Much ink and focus has been given of late to understanding China’s political evolution. Too little, on the other hand, has been given to what it will all mean to those of us who must decide what role China will play in our business plans in the next two to three years.

Futurism is alchemy in the best of circumstances, and nowhere more so than in the case of China. Nonetheless, if we extrapolate from current events, it appears that China has embarked on a course of commercial nationalism, if not outright mercantilism.

In the spirit of the season, then, we offer our five predictions for 2014:

1. China will build a more protected environment at home for its state-owned, state-coopted, and “accidental champion” enterprises through an increase in the use of soft protectionism.

2. Those enterprises will thrive at home, but increasingly will be pushed abroad, seeking prestige, less competition, and faster growth.

3. Trade and industrial policy will test the absolute limits of what China can get away with under the WTO, and Beijing will conduct a propaganda campaign to try and undermine the Trans-Pacific Partnership.

4. Foreign brands will find it more difficult to gain share in China. In addition to soft protectionism, they will face the continued relative decline in the prestige of foreign goods/brands in a growing number of sectors.

5. In 2014 we will see the beginnings of a new crop of Chinese entrepreneurs, more of whom will be starting their companies from second, third, and fourth tier cities, or even overseas. The cost and complexity of doing business in China’s first tier cities – along with the declining quality of life – will shift focus away from Beijing and Shanghai.

I’ll be addressing these more in the coming year.

Big Pharma, Bad Medicine, and What GSK Can Teach MNCs in China

Hutong West
Watching Louis Malle films
0813 hrs

I’m a little late to the bar with my take on this, but here it is, in three parts. Experienced China hands – go straight to the third section below.

When I first joined a global PR firm in China in 2000, I spent one day in my first week reviewing potential clients with my new boss. While my beat at the time was technology companies, I suggested we also look at pursuing some healthcare clients, maybe the big pharmaceutical companies. Surely, I thought, growing prosperity would send the demand for medicines skyrocketing, but local challengers would bring increasingly heated competition. A high-profit industry vulnerable to local competition sounded like the ideal client for us.

My boss gave a derisive snort and told me to forget big pharma. Seeing my confusion and taking pity upon the ignorant, she softened, and then gave me an eye-opening education in the ways of the pharmaceutical business in China. I won’t recount the details, but the gist was that pharmaceutical firms didn’t need public relations, because, allegedly, they marketed their wares in a rather more straightforward manner: they simply spiffed hospitals and physicians for prescribing the drugs.

Why spend money on PR, the thinking went, if what you needed was sacks of cash? I promptly forgot about Big Pharma in China until two weeks ago. Now it is clear that the plight of GSK and its cohorts is something none of us should forget.

The China operation of GSK stands accused of price fixing, of bribing doctors and hospitals by funneling those funds through travel agencies, hiding the bribes as travel costs and thus engaging in fraudulent financial accounting, and of conducting an internal investigation that failed to turn up any of these actions – actions the company now acknowledges were perpetrated by at least some employees.

This is an ugly litany, but it is not a new one. For over a decade it has been something of an open secret that some major pharmaceutical firms have been pursuing some variant of the pay-for-prescribe model. Doubtless, over the years many of those companies were counseled to cease such practices by employees and advisers. (There is some speculation as to why GSK was singled out as the monkey that would kill the chicken, but I’ll leave that to others.)

But one wonders whether, under the circumstances, GSK had a choice. It is a China business truism is that once a company has been through the market entry obstacle course and has begun generating (often spectacular) profits here, the pressure to sustain and grow that flow of cash is enormous. News about a company’s business in China moves the share price, and the prospects for business in the PRC is a key topic at a growing number of quarterly earnings calls. And the question is never “how” a company is doing business in China, but “how much.”

Capital, like justice, is willfully blind.

In a market where doctors make a pittance, where hospitals are overwhelmed yet constrained from charging reasonable rates for  care, the medical profession aches for streams of revenue that will keep the wheels on, if not line the otherwise threadbare pockets of underpaid physicians and administrators. Pharmaceutical companies foreign and domestic offer a ready source of cash, inciting a practice so pervasive that any drug firm unwilling to pony-up is simply not in the game. Add those pressures together, and a company could find itself fairly pushed down a slippery slope.

Having invested heavily for years in people and facilities and immersed in an industry where “everyone does it” and apparently gets away with it, it is easy to see why a company like GSK might be tempted – nay, compelled – to engage in behavior considered unethical or illegal elsewhere. At that point, the only alternative was to pack up and leave. This, it seems, was never an option.

And that is precisely the point.

GSK and several other multinational pharmaceutical firms look set to undergo a public revelation of the ugliest parts of their China businesses. That these revelations will damage the companies prospects in the world’s largest market is a given. All that remains to be seen is how far the Chinese government is prepared to go in sanctioning these companies for their past behavior.

Those events will take their own course. What must concern us now is a more urgent question: what other industries in China hide similar practices?

Already in the past week the Chinese government has taken to task the handful of international firms supplying infant formula to the Chinese market. The charge: price-fixing. Never mind that local companies in the same industry, by taking production shortcuts, have earned a reputation for sickening and killing children with their product, and that parents able to afford it in desperation have taken to buying imported formula often smuggled from abroad.

In so doing the government has sent a powerful message not once, but twice: no industry or company, however vital to the well-being of the Chinese people, will be allowed to engage in illegal and unethical business practices, and the foreign firms will be punished first and with greatest vigor.

In so doing, the government accomplishes three aims: it slows or stops practices likely to enrage the populace; it sends an unequivocal warning to its own local industry; and it cripples or eliminates foreign competition for its own local firms.

To every other multinational company in every other industry in China, ask not for whom the bell tolls. Xi Jinping’s administration has put the world on notice that no matter what local firms do, unethical and illegal business practices on the part of multinationals in China will no longer be tolerated, and in fact they’re coming for the foreigners first.

It is time for an immediate and thorough self-examination for the kinds of business practices that will not withstand government or public scrutiny. The time to clean up is right now, even if it cost contracts, relationships, and hard-won business. Failure to do so only puts off the reckoning and ensures that the cost will be much higher when that reckoning comes.

And there is one more lesson for the leaders and directors of any company that does or would do business in China, perhaps the most important of all.

A company entering the China market may well decide how much it is willing to spend in time, resources, and capital to attempt success there. No board worth its name would underwrite a leap into the PRC with a blank check: at some point, the cost is higher than it is worth. There would be no shame in such a decision, if for no other reason than the list of companies who have given up on China after finding no long-term payoff is long and distinguished.

But it is rare to find a company that has set an explicit limit on how far it is willing to go ethically to succeed in China, to say “here are the things we will absolutely not do in order to win in this market,” and gain board and shareholder support for that initiative. The readiness to define how much a company is willing to invest in the pursuit of success in China, but the failure to define how far it is willing to go to do so is what ensnares good companies like GSK in a web of worst practices.

And that is the lesson for all of us: if we do not draw a line in the ethical sand, stating in advance that our success in China will not be won at the cost of our ethical bottom line, we are effectively licensing the people building and operating our offices and operations in the PRC to do anything in the pursuit of financial gain.

Whatever your ethics, the Chinese government is now making clear the practical costs of pursuing such a path. If there is a future for foreign enterprise in the PRC, it belongs to companies who are prepared to live and die by a better standard of behavior, not to those who follow the lead of the meanest actors in the market.

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.

Business and The Xi Team: Focus on the Drivers

Xi Jinping 习近平

Xi Jinping 习近平 (Photo credit: Wikipedia)

In the Hutong
Information coma
1958 hrs.

Over the last couple of weeks, several people have asked me what the changeover in the Communist Party leadership will mean for international business in China. The short answer is that if I knew, I’d be wealthy. The longer answer is a bit more helpful.

Many years ago I had a mentor and boss who taught me that the parade of personalities and the flow of policies were fun to watch, but that sticking your finger up to feel the political winds would never offer the insight a business requires to make decisions beyond a six month threshold. What you need to understand, she told me, were the fundamental drivers of policy, not the policies themselves.

By fundamental drivers she meant the five or six issues that the nation’s leaders worried about the most, overlaid with the three core goals of the party at any given time. Add to that a general understanding of the climate in the country, and any relatively educated person could at least have a general hunch about a company’s horizons.

For example, I believe the thee core goals of the Party are:

  1. The continuance of Party rule
  2. The social stability of the nation
  3. China’s rise to global economic and political leadership

No rocket science there. Beyond this, though, things get tricker. What are the five things the members of the Politburo Standing Committee worry about when they wakes up at four o’clock in the morning?

Here is my list of the top five.

  • Controlling corruption without blackening the entire Party in the process
  • Getting the economy stabilized and on track for continuing growth
  • Keeping the PLA in line while retaining its political support
  • Cleaning up the environment without disrupting the economy
  • Keeping expressions of popular discontent from coalescing into a coherent anti-party front.

These are certainly open for debate, but what all of this suggests is that global companies will be welcome in China to the extent that they address (i.e., demonstrably take into account) these five priorities. What is more, given that domestic attitudes about foreign investment in China have, in the past five years, gone from “generally positive” to “generally ambivalent,” companies are going to find themselves compelled to make a case to their local stakeholders that they have something unique to offer just by being here.

Mind you, I’m not necessarily talking about approvals to do business, although that is an issue. Instead what I mean is that with every audience, from regulators to consumers, every business would do well to remember that being foreign no longer buys you much, and that in the current environment there is no particular priority placed on letting foreign firms into China.

In short, the outlook is not exceptionally good in the near term, but there is as yet little cause to be pessimistic. All of us need to stay tuned.

The Economist Nails the Case for Elections in Hong Kong

Consultation Document on the Methods for Selec...

Consultation Document on the Methods for Selecting the Chief Executive and for Forming the LegCo in 2012 (Photo credit: Wikipedia)

Leaving aside any ideological preferences one might have, The Economist makes a realist’s case for elections in Hong Kong.

In this case, though, there are practical reasons for China allowing a proper election, with non-acceptable candidates running too. It would bolster the mainland’s pitch to Taiwan: that “one country, two systems” means what it says. Full democracy may also be the safest option in Hong Kong. The uneasy coalition of Beijing’s supporters on the island—tycoons, party hacks, trade-unionists—could fracture under the weight of another ludicrous selection process. As for everyone else in Hong Kong, they showed in 2003 that when denied electoral outlets for their frustrations, they will take to the streets.

via Hong Kong’s chief-executive “election”: The worst system, including all the others | The Economist.

I can add two more: it would offer the world an opportunity to see the Party administering a high-profile local election, thus adding a much-needed bit of buoyancy to China’s bid for global soft power; and it would provide a laboratory for the Party in its own efforts to evolve.

Railway Reform is Coming to Town

In the Hutong
Managing Chaos
1311 hrs.

In a characteristically articulate editorial last week, Caixin called for an extensive overhaul of China’s Ministry of Railways (MoR) in the wake of the high-speed train crash in Wenzhou on July 23rd. The publication called for an open investigation into the accident conducted by experts from outside the control or influence of the MoR, for the functions of railway development, construction, operation, and regulation to be divided among independent entities, and for the folding of the resulting regulator into a larger ministry with a purview over the wider transport sector.

These changes are not without precedent in China. Aviation went through a similar change in the early 1990s, the telecommunications sector was similarly reformed five years later, and the energy sector has gone through a series of reforms that have separated the regulatory function from the business of generating and distributing energy. There are so many examples of where this has happened, in fact, that not only is the MoR something of a relic of China’s pre-reforming-and-opening past, it is also a matter of suggestive speculation as to why the MoR was left alone for so long.

So this sort of reform is overdue, and it looks like the higher organs of the Chinese government will try to unravel the hairball of conflicts-of-interest and mismanagement that serve as China’s railway industry.

Quis Custodiet Ipsos Custodes?

Unfortunately, even the measures suggested in Ciaxin’s excellent piece will not be enough. The world is replete with examples of industry-specific regulators who have become intertwined with – and co-opted by – the very industries they were created to regulate. One need look no further than the U.S. financial industry and its relationship with the Federal Reserve, the Department of the Treasury, and the Securities and Exchange commission to find proof, and there are ample additional examples.

The lesson of history is that regulators are most effective when they themselves are watched from the outside. While Caixin’s editors would be too modest (or timid) to say so, it is Caixin and all of the others who are watching the regulators from the outside who provide the best guarantee of a better and safer railway system for China.

Journalism, China, and Merton’s Law

In the Hutong
Struggling with November
2009 hrs.

The monitoring and censorship of China’s Internet is a matter of continuous outrage and fascination for audiences outside of China. And why not? It is superb theater. It pits the world’s extremist information libertarians against a faceless bureaucracy seeking to control information flow, and it provides a public forum to watch and gauge China’s evolving polity. As a result, the topic is of great interest to reporters covering China.

Most of the time, the attention journalists give to this ideological tug-of-war is either good, or at worst harmless. But there is one type of story that, when reporters cover it, they have the potential of doing a great deal of harm: what I call “loophole stories.”

Guess Who’s Reading Your Story?

Recently a reporter for a large global wire service ran a story wherein he/she revealed that owners of Amazon’s Kindle e-book reader devices in China could use the device’s built-in browser and circumvent the systems put in place by Chinese authorities to restrict access to websites deemed unsuitable for local audiences. The story has run, at my last count, in over 150 publications and websites in English alone around the world.

I understand the urges that motivated that reporter to cover the story: the sheer glee that China’s regulators had been foiled again, and the urge to pander to readers who would read the story as a triumph of technology over censorship.

But the consequences of running that story will be something else altogether.

Translators working at the Xinhua News Service, China’s wire service agency directly subordinate to the State Council Information Office, will see the story as they monitor the global news wires to which Xinhua subscribes. They will translate the story and, rather than run it over their own wire, they will include the piece among the stories that will be passed as a part of a daily internal briefing to the senior leaders of the government and Party.

Once the pesky loophole is called to the attention of the senior leadership, it must be dealt with, if for no other reason than to prove that the nation’s regulators are not the Keystone Kops the story implied they were. A way will be found to isolate Amazon’s Whispernet network and block it in China.

Loophole closed.

Congratulations, intrepid reporter. You will have assisted the authorities in making the censorship lid on China’s Internet all that much tighter. If it was your intention to do so, job well done. Your fellow foreign correspondents will, I am sure, be so proud.

Knowing When NOT to File

The pressures on a modern journalist, especially a wire service journalist, are brutal. Not only do you need to make sure you have every worthwhile story on your beat, you must also ensure that you file before everyone else. There is not a lot of time to weigh the moral and ethical issues around any given story.

But in a place like China, where the unintended consequences of a story could range from the infuriating to the downright deadly, those consequences must be understood and weighed. And when you have a doubt, you must have the courage to spike the story.

The Looming Crisis for Public Relations in China

I love PR (public relations)

Image by DoktorSpinn via Flickr

In the Hutong
Watching candy-wrappers blow in the wind
1818 hrs.

Gady Epstein and Imagethief have offered spot-on commentary about Mengniu‘s alleged hiring of a Beijing PR firm to disseminate libelous disinformation about a competitor. This sort of extreme case makes a good story, and hopefully there will be a few visible prosecutions to ensure these particular practitioners never twist the truth again.

But there are a wide range of activities in the public relations industry in China that, while they would be considered unethical or illegal elsewhere, are accepted practices here. While the practices in isolation may not seem egregious, they create an atmosphere of permissiveness that undermines the effort by many public relations people, both Chinese and foreign, to move public relations out of the sewer and into the boardroom.

Practices I have witnessed in the past decade include:

  1. Corporations and their public relations firms paying reporters a “transportation fee” of anywhere from RMB 200 – RMB 700 simply to come to a press conference or an interview, regardless of any relationship that fee has to the actual costs incurred.
  2. Public relations firms writing pro-client stories – essentially press releases in the style of a feature – for reporters to publish under their own bylines.
  3. PR firms pricing their services on a per-published-word basis, who, after taking a cut, then pay reporters to write reams of laudatory copy in return for a gratuity for each word published.
  4. Companies entertaining reporters at expensive restaurants, plying them with expensive gifts, or taking them on junkets.
  5. Companies paying reporters outright to write positive stories about them.
  6. Companies paying reporters outright to spike negative stories about them.
  7. Companies buying ads in newspapers in order to keep those publications for writing negative stories about them, with the reporter taking a commission on ad sales.
  8. Companies paying PR firms to hire people to go onto online forums and pretend to be consumers who love their company’s products (or who hate a competitor’s products). (We call it “astroturfing” because it fakes grassroots sentiment.)

These are not practices followed by all PR people or companies in China. There are firms and clients who are willing to put themselves at a short-term disadvantage in order to keep their practices above reproach, and they do so quietly. But the ethically-challenged practices remain altogether too common.

Until they are stamped out or drastically reduced, they will not only foster more scandals, they will undermine the credibility of China’s maturing news media in the eyes of the public. The government and the Party can afford neither. And therein lies a great danger for the PR business.

A PR industry truly interested in its future would move to put a stop to practices that may be considered unethical. If the motivation of protecting their clients against the kind of official attention Mengniu is getting these days is not enough to provoke a change, perhaps the specter of the government stepping in to regulate the industry in detail will be.

The global PR industry is not without its considerable ethical failings. Indeed, I reckon I will spend the rest of my professional life in a quixotic battle against spin as a substitute for true communications.

But it is early days in the evolution of China’s own craft of corporate communications. It would be a regrettable pity if that craft were to dissolve itself in the acids of disinformation and ethical compromise, right when it – and the companies it advises – most desperately needs to learn to communicate.

The Google Shuffle and the Hong Kong Twist

Airport Expressway, Inbound
Suffering from Pitch Fever
1241 hrs.

As we all take in the latest wrinkle in the Google vs. China story, a few thoughts. (Full disclosure: I own something like 5 shares of Google, Inc.)

Let Them Have It Both Ways

First, Google’s decision to redirect traffic to Hong Kong carries the faint scent of a company trying to have it both ways. On the one hand, Google would like to take the moral high ground with audiences worldwide, saying that it is no longer under the meaty thumb of Chinese government oversight.  On the other, it wants to be able to tell advertisers and shareholders that the company is still doing business “in” China, albeit from a sort of offshore data haven, and if possible maintain its #2 market position against Baidu. (Clearly, Google isn’t excited about leaving the worlds largest Internet market for a potential global competitor to dominate, or about creating a vacuum that would invite new competitors.) If they can pull this off, more power to them.

Success is not a given, however. In order to convince shareholders, they have to convince advertisers, and in order to convince advertisers, they need to maintain and build their user base. This means that the Hong Kong servers need to be as fast and easy to access as the servers were. It also means that the government needs to resist the temptation to block access to the Hong Kong search engine from China. 

Saving Face for Everyone

It is tempting to stop here and simply say “any bets on that one?” But this brings us to my second point. There will be some among China’s policymakers who will be tempted to block the Hong Kong Google service completely. There are better choices that would allow Chinese users and businesses to enjoy Google’s search and SEO capabilities while serving the purposes of the government. 

This is an excellent opportunity to demonstrate strength by exercising restraint. I don’t think unrestricted access to an offshore Chinese language search engine is in the cards. But it would be a simple matter for the central government to treat the same way they treat Google’s English services. Allow the site to remain accessible, but block searches that use terms the government finds objectionable. A nanny-moderated Chinese Google experience is better than none at all, and it gives China an opportunity to take a little high ground of its own. It would also serve to boost Google’s effort to expand its Hong Kong operations, something Hong Kong would surely like to see, and potentially help position Google as China’s Internet Entrepot. The SAR could sure use a boost, and seeing the central government take a stance that will benefit Hong Kong might help improve sentiment about Beijing on Jardine’s Rock.

It is not a perfect solution, but it is one that would allow both Google and the government – and Hong Kong – to come out of this better off. 

Unanswered Questions

Third, Sergei Brin’s high visibility on this issue raises more questions than it answers. As a child of the Soviet Union, Mr. Brin’s outspokenness on the China matter creates an unspoken (and not entirely accurate) parallel between China and the USSR that seems to bolster Google’s moral position. But it also keeps in the pubic eye a disturbing question: where was Mr. Brin in 2006 when Google made the original decision to operate a local China search engine under the terms spelled out by Chinese regulators? After all, the Hong Kong option was as open to Google in 2006 as it is today. Why did Google come ashore in the first place?

Did Mr. Brin or others strenuously object to the compromise and were overridden? If that is the case, what provoked the sudden change of heart? (And please, do not bring up the gmail hacks issue: that is an issue unrelated to the continued operation of the search engine.) Or was the company naive enough to believe that the reality of operating in China was at odds with its professed beliefs? 

These are not academic questions, nor are they relevant only to Google’s China business: they speak directly to the matter of the company’s corporate governance, and, of wider interest, to the way in which the company balances its moral stance with the temptation of business opportunities. As Google grows more influential and ubiquitous, it needs to make these matters clear to the public and, if necessary, rectify inconsistencies. Those of us who enjoy Google, its services, its software, and its share price want to know whether Google will truly be different as it grows, or whether it will simply become Microsoft-in-the-Cloud.

Posted via email from Silicon Hutong on Posterous

Beware of Dumb Investors

In the Hutong
Catching up
0916 hrs

Reading a thoughtful article a year after it was originally written might seem folly, but given that I am still running to catch up with my backlog means that I have no choice. And sometimes, that’s a good thing.

Perusing a Martin Wolf (no relation) column in the Financial Times from 8 March 2009 entitled “Seeds of it own destruction” is sobering. As the world’s stock markets were still in their half-year-long nosedive, he noted:

“The proposition that sophisticated modern finance was able to transfer risk to those best able to manage it has failed. The paradigm is, instead, that risk has been transferred to those least able to understand it. As Mr Volcker remarked during a speech last April: ‘Simply stated, the bright new financial system – for all its talented participants, for all its rich rewards – has failed the test of the marketplace.'”

It would be very easy for me to jump on the bandwagon of Main Streeters jumping all over Wall Street and scream for better regulation of the markets. While that may be part of the answer, the other part is an old adage my mom taught me when I first started following her at swap meets in Southern California as a kid:

Caveat emptor. Let the buyer beware.

The more you read through the details of the story of the crash, the more you realize that buyers, driven by greed, willingly bought financial instruments they didn’t understand on the basis the two factors you should never trust when purchasing a financial instrument: past performance and the assurance of salesmen of the security of the asset.

To be sure, there were other factors involved, but it is illustrative that the greatest assurance against having a bubble blow up in your face is a dose of clear-headed thinking.

Which brings us to China.

Chinese enterprises and individuals are being given opportunities to purchase financial instruments about which their only knowledge and understanding comes from the people who are selling said instruments to them. They are buying real estate with the absolute conviction that property prices only go up, they never go down. And they are doing all of this believing that if a crash happened, the government would step in and bail out individual investors.

The buyers are not aware, and this is an implicit danger the government is going to have to address in a broad, systematic manner in a way that doesn’t cause a run for the exits. So the question is, how do you inform a hundred million small investors without completely undermining confidence in the markets? Especially when there is no comparable, successful model that has ever been used elsewhere?

Or, believing that to be an insurmountable challenge, and recognizing the weaknesses underpinning China’s still-developing financial and property industries, do you not even open that can of worms, and instead choose to foot the bill when the air finally leaves the balloon?

This is important. Because if there is a single factor that is more worrisome about China’s economy than its real estate prices, it is the under-informed, over-trusting, investor living in a cloudcuckooland of moral hazard.

China’s Education and Great Wall Street

In the Hutong
Planning a Den Meeting
0834 hrs.

Superb article in The New York Times by Beijing’s own Didi Tatlow covering the issues she faces in putting her child into the Chinese educational system. It was fascinating to me as a parent, but what really grabbed me was this throwaway comment deep in the story from a friend who was commiserating with Didi about today’s Chinese school kids:

“Once, the nation’s elite wanted to be scientists and build their country. Today they want to be bankers, or stick with safe state jobs.

‘They don’t know what they want, but they hear bankers make the most money and everyone else is doing it, so that’s what they want to do,’ Hua said.”

China’s best and brightest don’t see a future in inventing or making things. They want to work for Goldman Sachs. Sounds familiar, doesn’t it? The story could just as well be quoting someone talking about undergraduates at any of America’s elite universities, as Don Peck does in the March issue of The Atlantic:

“…to an unprecedented degree, people who graduated from high school in the 2000s dislike the idea of work for work’s sake, and expect jobs and career to be tailored to their interests and lifestyle. Yet they also have much higher material expectations than previous generations, and believe financial success is extremely important. “There’s this idea that, ‘Yeah, I don’t want to work, but I’m still going to get all the stuff I want,’” Twenge told me.”

Two generations of young Chinese people have been told “to get rich is glorious,” they want to take the easiest route possible, and they see investment banking as that route.

China needs to cultivate a core of smart investment bankers to help the nation wisely invest its treasure, guide the consolidation of overbuilt industries, and extend its reach overseas. But does China want to become a nation led by its investment bankers in which the primary locus innovation is in arcane financial instruments? Or would the nation and its leaders prefer to be a global leader in science, in innovation, in solving the world’s problems and profiting richly therefrom?

If China starts siphoning its best minds into investment banking at the expense of other industries, teaching finance at the expense of creativity and innovation, the PRC may well follow America’s path into looming national insolvency.  To stop that, China’s youth need to be infused with a passion for not just doing well, but doing good.

No easy task.

Where Morozov is Wrong

In the Hutong
Recovering from Food Poisoning
1518 hrs.

Georgetown fellow Egveny Morozov wrote a must-read op/ed piece for The Wall Street Journal that is being Twittered a lot today, and deservedly so. He takes to task those who believe (including, apparently, the U.S. Secretary of State) that the route to global democracy is digital openness. This is little more than wide-eyed, hopeful utopianism, and Morozov makes a clear case for the Obama administration to back away from its current approach to Internet freedom around the world.

Where Morozov and I part ways is toward the end of the piece, where he notes:

“Diplomacy is, perhaps, one element of the U.S. government that should not be subject to the demands of “open government”; whenever it works, it is usually because it is done behind closed doors. But this may be increasingly hard to achieve in the age of Twittering bureaucrats.”

I disagree. While it would be undesirable to make Twitter and Facebook de-facto extensions of U.S. government policy, the role of public diplomacy (defined as the conduct of foreign policy by direct engagement with foreign audiences) in an increasingly transparent world is well appreciated by leaders of many of the worlds governments, including China’s. They understand that public support for the relationship between countries is increasingly as essential to strong international relations as whatever happens behind Morozov’s “closed doors.”

Public diplomacy has been dying in the United States since the fall of the Berlin Wall. This has been a foolish oversight, and Morozov is shortsighted to so lightly consign it to the dustbin just as the international relations experts are starting to ask how to most effectively update and use the tools for direct “G2C” outreach.

With public diplomacy in the early stages of a renaissance, the digital means of conducting such efforts will undoubtedly be awkward at first, but this is no reason to warn the U.S. government off of experimenting with such channels. As U.S. military and economic power wane, the Obama administration would be foolish to cast off whatever tools are available to ensure the continued influence of the United States in world affairs. We can be sure that the governments of India, China, and Russia, to say nothing of a host of non-state actors, will not do so.