Expert analysis by Thunderbird's Doug Guthrie: Potential Impacts of Coronavirus (covid19) and the Cost of Doing Business in Xi's China

The Novel Coronavirus and What it Means for China Today

By Doug Guthrie, Dashiell Chien, Chris Gao, and Diane Long

In this post (as with all of our posts), we seek to bring together a political economy analytical approach to a given issue with a boots-on-the-ground perspective of how an issue is actually playing out in China. In this case, our focus is the 2019 coronavirus (Covid-19), the epidemic that is seriously disrupting China today.

Key Insights

1. We are not public health experts but understanding the impact and reach of a phenomenon like Covid-19 requires more than a public health approach to the problem. It also requires an analysis of the political and economic context in which this crisis has unfolded; it requires a people-on-the-street understanding of what is actually happening in China today; it demands careful consideration of China’s evolving role in the global economy.

2. The economic impact of Covid-19 on China in the short term is unclear, as we do not yet know the extent or spread of the virus. However, the long-term economic impact will likely be small.

3. The political impact for the Chinese Government could be more significant. The Xi administration has aggressively centralized power and controlled the flow of information, more so than any leadership team in the last 40 years. People have largely accepted this as long economic and societal well-being continued to flow. However, if people begin to perceive that the administration’s control over the flow of information puts them at risk in some way (economically or health) things could swing another way. The government is approaching this issue as both a public health crisis and a political branding issue.

A Very Unfortunate Disease

Late last month, as the seriousness of Covid-19 was becoming clear, United States Secretary of Commerce Wilbur Ross noted, “I don't want to talk about a victory lap over a very unfortunate, very malignant disease… [But] the fact is, it does give business yet another thing to consider when they go through their review of their supply chain… So, I think it will help to accelerate the return of jobs to North America.” 

Leaving aside the complete insensitivity and callousness of this idiotic statement (sorry, Wilbur, you don’t get a pass for not “taking a victory lap”), more than that, it’s just silly. It is shocking that the secretary of commerce in the world’s largest economy would have such a facile understanding of something as important for commerce as global supply chains. Does he even understand how global supply chains work? As respected economist Simon Baptist from the Economic Intelligence Unit in Singapore put it, the comment was just “weird.” Baptist went on to elaborate, “Companies are not going to make serious and long-term investment decisions on the basis of an outbreak of a disease that might last three to six months.” Again, Wilbur: “weird.” 

Without a doubt, the spread of the coronavirus (新冠肺炎) has moved startlingly fast – about 32,000 cases worldwide as of today, compared to about 8,000 total cases for SARS over a much longer period. The mortality rate is significantly lower than compared to SARS (about 2 percent for the Covid-19 versus about 10 percent for SARS). Within a month of first being alerted to the virus by the Chinese Government, the World Health Organization (WHO) declared the outbreak a global emergency. There is no doubt this is a serious situation. Let’s consider the issue along a few key dimensions: economic, political, and social.

Economic Impact 

As some pundits and politicians are making the case for the downfall of China’s economy, let’s look at this from the perspective of history and China’s economic fundamentals. First, a little history. The impact of SARS in 2003 is well-documented. The Chinese economy took a hit of about 2 percentage points on year-on-year GDP growth for Q1 2003 (a drop from about 11 percent to about 9 percent). The economy recovered in the second half of the year, but the net result was about a 1 percentage point dip in China’s overall GDP growth for the year against projected growth. These numbers always must be viewed in the context of the overall size of the economy. In 2003, China’s economy was about $1.7TN (about 4 percent of the global GDP), while China’s economy today is about $14.4TN (about 17 percent of the global GDP). Some economists have argued that this difference in size means that the impact of a slowdown will be much larger today than it was 17 years ago. 

That is possible, but we have to take into account other economic factors as well. Most economists we trust predict that China might anticipate a .4 to .6 percentage point drop in GDP growth as a result of the coronavirus. Based on these forecasts, the worst-case scenario is that China’s growth might sink to 5.2 percent. Let’s be clear: we are talking about a once-in-a-decade crisis for the world’s second-largest economy, and we are talking about 5.2 percent growth. These are growth rates that Donald Trump can only dream about. (Recall that Trump predicted 4-5 percent growth under his stewardship, but he has never cracked 3 percent.) So, a little perspective here when we are talking about a “radical” decline or slowdown in China’s growth.

China is transitioning from export-led growth to investment-led growth to consumption-led growth. China sits somewhere in between investment- and consumption-led growth today. Trust us, the Xi Jinping administration doesn’t worry too much about a 1 percentage point drop in GDP growth. Countries that have accelerated growth through investment in infrastructure can pretty easily put their thumbs on the scale of GDP growth by continuing to invest in infrastructure, creating more jobs, building more “stuff”, etc. The debt the government needs to take on to do this cannot be ignored (thus the debt-to-GDP ratio comes into play), but the Chinese Government can always find the resources to stimulate growth if it so desires. If you are going to inject a $1TN stimulus into the economy, you are much better off injecting it into building infrastructure than in giving tax breaks to corporate executives for share buyback programs, which do nothing for line workers or corporate R&D investments.

Finally, a few words about the structure of the Chinese economy today. A number of economists have predicted more dire consequences of Covid-19 than SARS because China’s consumption-based economy has risen from 44 percent to 57 percent. The argument goes that if people don’t venture out to buy things, a larger portion of the economy will take a hit today as compared to 17 years ago. What is never mentioned is how much more mobile the Chinese economy is today compared to 2003. People may be staying inside during this crisis – indeed the streets in major cities like Shanghai are empty – but that doesn’t mean they aren’t buying things. Just stand at the entrance of any residential compound in Shanghai to watch the courier mopeds line up to drop off a myriad of boxes and bags in all shapes and sizes. People may not be venturing out to stores, but RMB is definitely still flowing. China’s mobile/online economy is the most powerful and dynamic mobile economy in the world, and it is a little unclear how a crisis like this affects that economy.

A couple of nights ago, two members of our team went out to dinner in Shanghai and found an empty restaurant. When they asked the owner if his business was suffering, his answer was, “Well, a little bit, but we have just become a takeout establishment overnight. We’ll get back to regular business when people start coming out again. But right now, we are responding to demand with delivery and the mobile economy to fill the gap.” So, the mobile economy makes the economic impact even more unpredictable. 

A key point on the economic impact: The Ross statement lays bare a complete lack of understanding of how manufacturing supply chains work in China and Asia more generally. The most profitable manufacturers in the world – whether in automobiles or electronics – deal with so many suppliers in any given supply chain that the idea of “moving manufacturing back to the US” requires much more thinking than politicians like Ross and US trade czar Peter Navarro seem to understand. These supply chains are supported by the Chinese Government. They invest heavily in R&D. They focus on the support of technical vocational education to support the line workers that build these products. The situation is so much more complicated than a simple virus-as-impetus-for-building-factories-in-America view of the world. We’ll see how things play out, but the script is far from written yet.

Political Impact 

Two weeks ago, at a China panel, an audience member raised the question of whether Covid-19 could be a threat to the Xi regime. At the time, my answer was: “Not a chance. The Hong Kong situation is a much greater risk for Xi’s administration than the coronavirus, the impact of which will pass within six months at the outside.” My logic was the following: In the era of economic reforms, the Chinese Government made an implicit deal with Chinese citizens – let’s put off political reforms, and we promise that life in China is going to get better and better. This promise was mostly an economic one, and the government has basically delivered on that promise. And no one is going to radically downgrade China’s economy based on a 1-2 Quarter societal disruption. So, my logic was, there could be a major disruption (for example a crackdown in Hong Kong), but Covid-19 was not going to be it.

Now, I’m not so sure. This is a serious time for Xi’s administration. It is no secret that Xi has been very aggressive in controlling the flow of information over social media. There are many stories about the deleting of posts and the censoring of information. For the current case, the idea that the initial whistleblower, the heroic Dr. Li, who tragically passed away February 6 as a result of exposure to the virus he identified, was admonished for spreading “rumors” over social media has raised a significant amount of ire across China. It is one thing to censor information about negative views of the government, for example, but censoring information about the social good – and the health of your people – crosses a line in many Chinese citizens’ eyes. 

There is a sense that the Central Government’s control over information has created a culture that stifles the flow of information. This is a reality that has been generally accepted by the Chinese population. The Chinese population willingly bought into the quid pro quo exchanging political transformation (or lack thereof) for economic development. When the Chinese Government stifles the flow of information, the Chinese populace, for the most part, is willing to abide by the censorship. Today, Chinese citizens discuss this agreement fairly explicitly: citizens of China openly acknowledge that the Party guarantees political stability (稳定), safeguards (保障), and economic development (经济发展); in return, society must avoid chaos (中国不能乱). So, when the Chinese Government censors the flow of information, for the most part, the Chinese populace is willing to abide by this quid (censorship and control) as long as they get their quo (economic development).

Yet, this exchange only works if it doesn’t wander into the realm of public safety and social well-being. If the government’s control over the flow of information has implications for what people know about the safety of their health, things might get messy. And there have been plenty of public complaints about the government’s lack of transparency in this particular crisis.

In addition, it remains unclear what the Central Government actually thinks of this crisis – is it a public health crisis or a public-image crisis? On January 26, the Central Government formed the Central Leading Group for Coping with the Novel Coronavirus Pneumonia (中央应对新冠肺炎疫情工作领导小组). This emergency task force, led by Li Keqiang, is comprised of high-level party and state personnel, including politburo and minsters in charge of policy, propaganda, foreign affairs, and public security. Oddly enough, there were no public health officials. The closest we get to a health presence on the committee is Mme. Sun, who is Vice Premier in charge of cultural, education, and health areas. However, she is not a public health official in the strictest sense. Interestingly, the line-up looks more like a production team for a major event than it does a public health emergency or disaster-recovery group.

Societal Impact

Chinese society has been through this before. The most immediate antecedent is SARS, and the parallels between SARS and Covid-19 are obvious. But if we extend beyond the virus to the ways Chinese society turns inward to their own internal social networks, we find an interesting pattern. There are many historical precedents of this turn – the Cultural Revolution, the aftermath of the Great Leap Forward, and the mass campaigns of the 1950s. Chinese society – no matter if its Central Government is responding in the right or wrong way – has a tendency to turn inward, focus on its own network ties, and defend the boundaries of its own social network. 

Because China's local dialects are so distinctive, people can often be identified as being from a given place. In crises such as this one, discrimination can spread swiftly and widely. If you are from Hubei, you are a target in China right now. An extended family member of one of our team reported the following: In her building complex, it was widely known that one family came from Hubei province. After the Chinese New Year, as people were returning from their annual treks to their hometowns, Public Security Bureau (PSB) officials were waiting for this family. They were not allowed to enter their home and were taken directly to the PSB Station and then transferred to one of the “isolation motels” for 14 days of observation. They hadn’t done anything wrong; they were just from Hubei. There is also the reported case of the Shanghai residents who refused to board an international flight from Nagoya to Shanghai because individuals from Hubei were also boarding the flight. These moments make it clear how Chinese internal social networks can circle the wagons very quickly in times of crisis. 

This type of prejudice also extends beyond provincial and hometown location. For example, the City of Wenzhou is known to be a very entrepreneurial city in the center of Zhejiang province. Wenzhou entrepreneurs made a lot of money in the early years of the reforms, and they began to invest together around the country and throughout the world. They invested in coal in Shanxi; real estate in Shanghai; restaurants in France and Italy; and, most recently, they became major investors in real estate and wholesale operations in Wuhan. In the current crisis, the suspicion surrounding anyone from Wenzhou, whether or not they are part of the Wuhan real estate investment club, is real. 

This discrimination isn’t the sole province of the Chinese. There is also the international side of the equation, and this situation seems to tiptoe up to the line of outright racism. Discussions of Chinese “wild animal markets” or the “rampant spread of viruses in China” [both phrases can be found on the Internet with simple Google searches] should strike fear in anyone who is sensitive to notions of Chinese essentialism or, dare we say, racism. Now, there is certainly a clash of cultures and economic development here. China is a place that enjoys and protects exotic markets in goods and animals. It is also a place that sends and exports more people and capital to the world than any other country in the world. It is a country that sends more foreign students than any other country in the world; it is a country that sends more tourists around the world than any other country in the world. So, we come to a clash of cultures, a clash of worlds. 

A Rare Common Ground

What will be the impact of Covid-19 in China be in 2020? Our view is that the economic impact is likely overblown. There are real issues here, but China is in the economic development game for the long haul. It is orchestrating the economic development process as adeptly as is possible for a country of its size. That doesn’t mean there won’t be disruptive effects from the virus, both politically and socially. This could have implications for the Central Government’s authority, but we also believe these will likely blow over. The extent of the current societal rebellion over the government’s handling of this crisis remains noteworthy, and we will continue to watch with interest. Ironically, and unfortunately, the virus has created common ground between Chinese society and the world: For both, the answer to a public health crisis is fear, exclusion, and discrimination. In this sense, both China and the world have a lot of work to do.

Original post: https://ongloballeadership.com/f/the-novel-coronavirus-and-what-it-means-for-china-today

The Age of Cooptation: The Cost of Doing Business in Xi's China

(Business, China, China Capitalism, International Trade, Supply Chain, Xi Jinping, Covid19, Coronavirus)

By Doug Guthrie

The cost of doing business in China today is a high one, and it is paid by any and every company that comes looking to tap into its markets or leverage its workforce. Quite simply, you don’t get to do business in China today without doing exactly what the Chinese government wants you to do. Period. No one is immune. No one.

As someone who has lived and worked in China, advised companies about investing there and quite happily been described as a China bull, I have struggled to accept this fateful conclusion in the era of Xi Jinping. Like some other China Bulls, I had believed the early promises of Deng Xiaoping, Jiang Zemin, and Zhu Rongji about China’s fair and open future, open markets, the emergence of a rule of law system. To be clear, I am still very bullish on the strength and trajectory of the Chinese economy – China *will* continue to grow and it *will* surpass the US as the largest economy in the world. However, the current era is just a much darker period for everyone, including Multinational Corporations (MNCs). 

Recently, while listening to the savvy Pivot podcast, I was reminded of how far we’ve come from that dream, as tech gurus Kara Swisher and Scott Galloway discussed the U.S. trade war with China, China’s economic belligerence, and the problematic alliances international corporations make when seeking to plant their flag on Chinese soil. 

It was interesting to hear Galloway’s take on China because it reflects my own conclusions about doing business in China in the era of Xi Jinping. I am not in the prediction business and thus don’t know if Galloway is right about which companies we are going to hear about in China in the coming year. But I do know that he has suggested an important line of discussion for the coming years: What does it cost to do business in China in the Era of Xi Jinping? My own view: There is no free lunch for doing business in Xi's China – especially for technology companies. China *will* get its pound of flesh as the cost of operating there: you get to operate here and gain access to the most innovative supply chain in the world and world's largest marketplace, and China gets what it wants in terms of benefits to Chinese economy and society (as defined by the Chinese Government).

A Little History

I have spent my career as a China scholar, and I think of Shanghai as my second home, having done three extended “tours of duty” in that great city over the last 30 years. My first book, based on my time there in the 1990s, was about the transformation of the Shanghai industrial economy and what it meant for China's economic transformation. Most recently, from 2015 to 2019, I was a senior director at a Multinational Corporation (MNC), again based in Shanghai. These experiences have given me a unique perspective on the questions raised by Professor Galloway.

In the mid-1990s, when I was in the early days of my China research journey, I used to spend time consulting for MNCs on strategic market entry into the world’s most populous nation. Back then, the dynamic was very clear: consultants and executives would inevitably find themselves sitting across the table from a couple of Chinese officials; they would say, ‘here’s the deal: you are going to do a joint venture with this company, this company, or that company, and you are going to transfer technology along the lines of this technology transfer schedule; or you can go home and not have access to this manufacturing base or the world’s largest market.’ Technology transfer and 'helping' China were at the heart of joint venture agreements, and this dynamic was unavoidable if technology-driven companies wanted access to the Chinese market. There were a few exceptions in light industry goods (think garments, running shoes, plastic toys), where the technology was less important. But for companies that had something that China wanted, this was the cost of doing business there.

Then, in the early 2000s, two things happened. First, in 2001, China entered the World Trade Organization (WTO). Overnight, it became illegal (or at least against WTO rules) for Chinese officials to demand a quid pro quo for market access. Second, in 2002, Jiang Zemin and (more importantly) Zhu Rongji came to the end of their two terms leading China. They were replaced by Hu Jintao and Wen Jiabao, who were much weaker than their predecessors. So, in very short order, China became a playground for MNCs that wanted cheap labor, the world’s most innovative supply chain, and the world’s largest market. (Note: Apple entered China in 2001, so, from 2001-12, this was the China they had come to know.) 

The era of Hu and Wen (2002-2012) can be viewed as a relatively laissez-faire period in the 40 years of China’s “economic opening.” There was a significant drop-off in joint venture deals (those officials were not sitting on the other side of the table anymore); companies like Apple, Walmart, and Nike could manage the supply chain as they liked; and the much-hyped 1.4-billion-person marketplace opened up significantly. Most China watchers, myself included, were expecting an authoritarian or centralizing shift in the political transition of 2012. I don’t think any of us imagined how aggressive the authoritarian shift was going to be, however. 

For a company like Apple, the first shot across the bow came on March 15, 2013. Every year, on March 15, China holds an annual ritual called “International Consumer Day,” where the state media chooses one or two corporations to shame for bad corporate practices – almost always foreign corporations with significant operations in China. In 2013, it was Apple’s turn. (President Xi officially began his first term on March 14, 2013, so this was the first Consumer Day he presided over.) 

Apple was targeted for warranty practices in China. Tim Cook formally apologized, and the world moved on. But it was significant to note that the tech sector was on notice. The basic tone that would re-emerge over the next couple of years would harken back to that of the 1990s: If you are not helping China through partnerships or outright technology transfer, you are no longer welcome in China. 

And China used the law to reinforce its new mindset, with a strong reinvigoration of the "Rule By Law" system of governance. (Note: There is an important distinction between "Rule of Law" systems, typical of Western Democracies, which have independent Judiciaries, and the Chinese Rule By Law system, which uses the law to force individuals and companies to do what the government wants. I will discuss this distinction in a later post.) Statutes such as The Dispatch Labor Law and The Cybersecurity Law were designed to send the signal that the requirements of doing business in China were going to be significantly different going forward. In short, the Dispatch Labor Law was set up to control the use of the internal migrant labor population (the so-called “floating population”) and the Cybersecurity Law was set up to control the flow of data and content. Both laws were set up to control the ways in which high tech companies operating in China – both in terms of outsourced manufacturing and in terms of technology transfer. 

In relatively short order, most if not all major companies operating in high-tech sectors, including some of the most powerful MNCs in the world, unveiled ways to show they were giving back to Chinese society, from major investment announcements (Dell) to joint venture announcements (Dell, HP, IBM, Qualcomm, Cisco, Intel) to R&D centers and data centers (Apple) to incubators and accelerators (Microsoft). The list goes on. And from the exclusion of Facebook, Google, and Twitter to the shuttering of Apple’s iTunes Store (iBooks and iTunes Movies) in April of 2016, the Chinese government made clear what it is willing to do to protect its domestic champions and control the flow of information. This is what it means to be intimately involved with an authoritarian government – you do what the government wants or you can leave. 

But this isn't just about foreign MNCs operating in China. Xi has also built a close alliance with the major domestic players in technology sectors. The government has always had direct control over the major players in the state sector (like ZTE), but private companies (like Huawei) have kept an arms-length distance from the government. Until now. 

Realizing that making the difficult transition from investment-led growth to consumption-led growth, Xi enlisted companies like Baidu, Alibaba, and Tencent (the so-called BAT). While the Chinese Government has protected BAT from global powerhouses like Google, Facebook, and Twitter, two of them (Alibaba and Tencent) have thrived and also become the two largest investors in Chinese entrepreneurial endeavors, thus helping to build the consumption-led growth economy.

But there is a quid pro quo in play here: the Chinese Government protects its national champions, but the Government also wants their data. The situation with Alibaba has been clear and Alibaba has been upfront about this with its contributions to the emerging social credit system; Tencent has been less forthcoming, but we know that the government is monitoring and censoring WeChat aggressively. The government wants access to the data, and that desire is backed up by the Cybersecurity Law. And make no mistake about it, the government is using the data for a very sophisticated social monitoring program. Again, you don’t get to do business in China without playing the game that the government wants you to play, and this is the game right now. No one is immune. No one.

A Telling Change

{NOTE: Huawei executives vociferously deny the contents of this section of the original post. While the author stands by the research, he also acknowledges the disagreement over the content of the conversations with Huawei executives. He takes full responsibility for any errors reported herein. As a result of this disagreement, we have deleted this section. Also note that Senior Vice President and Director of the Board of Huawei, Madame Chen, has written a response to the original post, which is posted on this site:https://supchina.com/2020/02/12/the-age-of-cooptation-the-high-cost-of-doing-business-in-xis-china/} 

The Bottom Line

All of the cases depicted here are examples of the close collaboration between Xi’s government and the private sector – especially the high-tech sector. And there are many other examples, including foreign companies. This is the cost of doing business in China in Xi’s Age of Cooptation. What does this mean for foreign companies doing business in China today? Galloway predicted that we are going to hear a lot more about this issue in the coming year. He might be right. The bottom line is this: if you are not helping China develop in the areas it wants to develop, you are no longer welcome. Whether it is data centers, 5G technology, or infrastructure that will help with the Belt and Road Initiative, there has to be a benefit for China. This is the cost of doing business in China today.

Doug Guthrie has been a China scholar since the late 1980s when he began studying Chinese language, literature, and history at the University of Chicago. After graduate work at the University of California, Berkeley, he was a Professor of Management and Sociology at New York University for several years (1997-2010) and served as Dean of the School of Business and Vice President for University China Operations at the George Washington University (2010-14). From 2014-2019, he was a Senior Director at Apple and was based in China. Currently, he is Professor of Practice and Director of China Initiatives at the Thunderbird School of Global Management.

Originally published at: https://ongloballeadership.com/f/the-age-of-cooptation-the-cost-of-doing-business-in-xis-china 

Please contact Jonathan Ward via phone or email to coordinate an interview or request a comment from Professor Guthrie on a specific issue such as the potential business impacts of the covid19 novel coronavirus.