Who's Deluded over China: American Business or just the Pundits? by George P. Koo
International Strategic Alliances
Mountain View, CA 94043
Business Journal, 4/28/97 and Asian Week, 4/4/97

Since the anti-China hysteria in the U.S. has not been able to deter the recent high profile visits to China by Vice President Gore and House Speaker Gingrich, the China-bashing devotees have shifted their focus. They now question whether doing business with China makes economic sense.

One tactic is to make the outright claim that there is no possibility of doing business with China profitably, even though such question flies in the face of many American companies who have been there for many years. Given the quarterly bottom line focus that dominates Wall Street, it does not seem plausible that companies such as 3M, Hewlett-Packard, Johnson & Johnson, Coca-Cola, Procter & Gamble, S.C. Johnson, Motorola, IBM, Kentucky Fried Chicken and McDonald's among many others who have been there for up to a decade or more could delude themselves for long merely waiting for the pursuit of profit to solidify into reality. If their China operations have not been profitable, they wouldn't be there. In fact, two surveys of multinational companies already in China by the Economist Intelligence Unit and Andersen Consulting found that most turned a profit sooner than expected (Wall Street Journal, 9/15/95).

Some even pooh-poohed the Boeing sales in China concluded during Vice President Gore's visit as not having a dime's worth of profit. In recent years, sales to China represents anywhere from one in ten to one in seven planes rolling out of Boeing's manufacturing hangar. No arguement based on economies of scale in aircraft production or some other rational basis could justify selling planes to China at a loss. In response to the announcement of the latest deal in Beijing, the stock market promptly sent Boeing's stock up by more than a couple of dollars. Obviously, at least Wall Street believes that there are more than a few dimes to be made by the company from the sale.

Even companies that have yet to notch up significant sales, such as Applied Materials and other semiconductor equipment companies, are building their bases in China now. These companies are convinced that the development of the semiconductor industry driven by its growing economic strength is inevitable in China just as it had in Japan, South Korea, Taiwan and elsewhere in Asia. However emotionally satisfying it might be to stay home in a snit, doing so risks losing out in the world's next dynamic market for high technology equipment.

Others scream about ballooning trade deficits between the United States and China and claim unfair Chinese trade policy as the cudgel to keep anti-China sentiments at fever pitch. In the process, some bookkeeping inconsistencies are conveniently overlooked. While the trade deficit has been increasing every year, the deficit that the United States used to have with Taiwan and Hong Kong has been rapidly decreasing. Why? Because much of the labor intensive operations have been shifted into mainland China by the Taiwan and Hong Kong businesses. By looking at the total trade deficit with greater China, as Nicholas Lardy of Brookings Institution has done, the year-to-year increase has been much less dramatic.

As Lardy pointed out (Wall Street Journal, 2/7/96), part of the trade gap is exaggerated by the way the U.S. government looks at the trade statistics. Exports from China via Hong Kong are counted as from China including any value added by the Hong Kong entity. On the other hand, U.S. exports to Hong Kong are not credited to China for the significant portion that are transhipped into China. The trade deficit claimed by the U.S. government for 1995 was $35 billion. A more realistic gap, adjusting for Hong Kong's intermediary role, would have been $23 billion.

Furthermore, China derives the trade surplus by selling toys, clothing, footwear, common household items and other labor intensive but low cost goods. If we do not buy from China, we would have to (and we do) buy from other developing countries that can offer such goods at a reasonable price. There is nothing insidious about China's success; it's just simple economics. Unlike the military, American consumers can't afford to indulge in feel good, buy America if it means paying for $500 hammers.

While we have a legitimate complaint that China is not buying enough from the U.S., the detractors' claim that China's market is closed to American goods is a rather extreme conclusion. U.S. exports to China exceed $10 billion a year and, even though on a jagged trend line, have been averaging over 20% per year increase since 1978. In recent years, China has been a major customer of telecommunication equipment from the U.S. and other western nations. Just from the U.S. along, China's annual purchase will soon exceed $1 billion.

Certainly no one will claim that doing business in China is easy. However, just because the U.S. has the two largest trade deficits with Japan and China is not sufficient reason to tar both with the same brush. The two are vastly different not only in economic development but also in their government policy towards trade. Japan has been correctly criticized in their past for their deliberate mercantile policy that accumulates a total world trade surplus every year. Since its economic reform led by the late Deng Xiaoping in 1978, China enjoyed about as many years with overall trade deficit as trade surplus and no apparent pattern emerges from the ups and downs.

High import duty and the confusion during China's transition from a planned economy to a market driven economy as well as infrastructure bottlenecks have hampered foreign sales into China. But these conditions are changing. In their own interest, China needs to reduce duty and thus become world competitive, to protect intellectual properties and thus promote domestic industries based on patents and trade secrets, and to streamline bureaucracy and eliminate corruption so as not stifle continued economic growth. These changes are taking place and they will benefit western companies that are there.

The American public may be surprised to know that China also enjoys a trade surplus with Japan. Asia is now Japan's largest market, exceeding the combined total of North American and Europe--a little known fact in the U.S.-- and Japan sells $4 to Asia for every $3 it buys from Asia. Yet with China, Japan only sells $2 to every $3 it imports. How come? Japan's electronic firms such as Matsushita, Sanyo, Sony et al. have been moving their low end manufacturing into China. Today Japan imports more color televisions from their satellite plants in Asia than they manufacture domestically. Some of the color TVs and much of the low end audio equipment come from China. It may not be perfect and it may not be totally free, but laws of economics do seem to be working and unlike some members of Congress, the Japanese government has yet to make a fuss.