Authors: Thomas L. Friedman
In 1977, Chinese leader Deng Xiaoping put China on the road to capitalism, declaring later that “to get rich is glorious.” When China first opened its tightly closed economy, companies in industrialized countries saw it as an incredible new market for exports. Every Western or Asian manufacturer dreamed of selling its equivalent of 1 billion pairs of underwear to a single market. Some foreign companies set up shop in China to do just that. But because China was not subject to world trade rules, it was able to restrict the penetration into its market by these Western companies through various trade and investment barriers. And when it was not doing that deliberately, the sheer bureaucratic and cultural difficulties of doing business in China had the same effect. Many of the pioneer investors in China lost their shirts and pants and underwear- and with China's Wild West legal system there was not much recourse.
Beginning in the 1980s, many investors, particularly overseas Chinese who knew how to operate in China, started to say, “Well, if we can't sell that many things to the Chinese right now, why don't we use China's disciplined labor pool to make things there and sell them abroad?” This dovetailed with the interests of China's leaders. China wanted to attract foreign manufacturers and their technologies-not simply to manufacture 1 billion pairs of underwear for sale in China but to use low-wage Chinese labor to also sell 6 billion pairs of underwear to everyone else in the world, and at prices that were a fraction of what the underwear companies in Europe or America or even Mexico were charging.
Once that offshoring process began in a range of industries-from textiles to consumer electronics to furniture to eyeglass frames to auto parts-the only way other companies could compete was by offshoring to China as well (taking advantage of its low-cost, high-quality platform), or by looking for alternative manufacturing centers in Eastern Europe, the Caribbean, or somewhere else in the developing world.
By joining the World Trade Organization in 2001, China assured foreign companies that if they shifted factories offshore to China, they would be protected by international law and standard business practices. This greatly enhanced China's attractiveness as a manufacturing platform. Under WTO rules, Beijing agreed-with some time for phase-in-to treat non-Chinese citizens or firms as if they were Chinese in terms of their economic rights and obligations under Chinese law. This meant that foreign companies could sell virtually anything anywhere in China. WTO membership status also meant that Beijing agreed to treat all WTO member nations equally, meaning that the same tariffs and the same regulations had to apply equally for everyone. And it agreed to submit itself to international arbitration in the event of a trade dispute with another country or a foreign company. At the same time, government bureaucrats became more customer-friendly, procedures for investments were streamlined, and Web sites proliferated in different ministries to help foreigners navigate China's business regulations. I don't know how many Chinese actually ever bought a copy of Mao's Little Red Book, but U.S. embassy officials in China told me that 2 million copies of the Chinese-language edition of the WTO rule book were sold in the weeks immediately after China signed on to the WTO. To put it another way, China under Mao was closed and isolated from the other flattening forces of his day, and as a result Mao was really a challenge only to his own people. Deng Xiaoping made China open to absorbing many of the ten flatteners, and, in so doing, made China a challenge to the whole world.
Before China signed on to the WTO, there was a sense that, while China had opened up to get the advantages of trade with the West, the government and the banks would protect Chinese businesses from any crushing foreign competition, said Jack Perkowski of ASIMCO. “China's entry into the WTO was a signal to the community outside of China that it was now on the capitalist track for good,” he added. “Before, you had the thought in the back of your mind that there could be a turning back to state communism. With WTO, China said, 'We are on one course.'”
Because China can amass so many low-wage workers at the unskilled, semiskilled, and skilled levels, because it has such a voracious appetite for factory, equipment, and knowledge jobs to keep its people employed, and because it has such a massive and burgeoning consumer market, it has become an unparalleled zone for offshoring. China has more than 160 cities with a population of 1 million or more. You can go to towns on the east coast of China today that you have never heard of and discover that this one town manufacturers most of the eyeglass frames in the world, while the town next door manufacturers most of the portable cigarette lighters in the world, and the one next to that is doing most of the computer screens for Dell, and another is specializing in mobile phones. Kenichi Ohmae, the Japanese business consultant, estimates in his book The United States of China that in the Zhu Jiang Delta area alone, north of Hong Kong, there are fifty thousand Chinese electronics component suppliers.
“China is a threat, China is a customer, and China is an opportunity,” Ohmae remarked to me one day in Tokyo. “You have to internalize China to succeed. You cannot ignore it.” Instead of competing with China as an enemy, argues Ohmae, you break down your business and think about which part of the business you would like to do in China, which part you would like to sell to China, and which part you want to buy from China.
Here we get to the real flattening aspect of China's opening to the world market. The more attractive China makes itself as a base for off-shoring, the more attractive other developed and developing countries competing with it, like Malaysia, Thailand, Ireland, Mexico, Brazil, and Vietnam, have to make themselves. They all look at what is going on in China and the jobs moving there and say to themselves, “Holy catfish, we had better start offering these same incentives.” This has created a process of competitive flattening, in which countries scramble to see who can give companies the best tax breaks, education incentives, and subsidies, on top of their cheap labor, to encourage offshoring to their shores.
Ohio State University business professor Oded Shenkar, author of the book The Chinese Century, told BusinessWeek (December 6, 2004) that he gives it to American companies straight: “If you still make anything labor intensive, get out now rather than bleed to death. Shaving 5% here and there won't work.” Chinese producers can make the same adjustments. “You need an entirely new business model to compete,” he said.
China's flattening power is also fueled by the fact that it is developing a huge domestic market of its own. The same BusinessWeek article noted that this brings economies of scale, intense local rivalries that keep prices low, an army of engineers that is growing by 350,000 annually, young workers and managers willing to put in twelve-hour days, an unparalleled component base in electronics and light industry, “and an entrepreneurial zeal to do whatever it takes to please big retailers such as Wal-Mart Stores, Target, Best Buy and J.C. Penney.”
Critics of China's business practices say that its size and economic power mean that it will soon be setting the global floor not only for low wages but also for lax labor laws and workplace standards. This is known in the business as “the China price.”
But what is really scary is that China is not attracting so much global investment by simply racing everyone to the bottom. That is just a short-term strategy. The biggest mistake any business can make when it comes to China is thinking that it is only winning on wages and not improving quality and productivity. In the private, non-state-owned sector of Chinese industry, productivity increased 17 percent annually-I repeat, 17 percent annually-between 1995 and 2002, according to a study by the U.S. Conference Board. This is due to China's absorption of both new technologies and modern business practices, starting from a very low base. Incidentally, the Conference Board study noted, China lost 15 million manufacturing jobs during this period, compared with 2 million in the United States. “As its manufacturing productivity accelerates, China is losing jobs in manufacturing-many more than the United States is-and gaining them in services, a pattern that has been playing out in the developed world for many years,” the study said.
China's real long-term strategy is to outrace America and the E.U. countries to the top, and the Chinese are off to a good start. China's leaders are much more focused than many of their Western counterparts on how to train their young people in the math, science, and computer skills required for success in the flat world, how to build a physical and telecom infrastructure that will allow Chinese people to plug and play faster and easier than others, and how to create incentives that will attract global investors. What China's leaders really want is the next generation of underwear or airplane wings to be designed in China as well. That is where things are heading in another decade. So in thirty years we will have gone from “sold in China” to “made in China” to “designed in China” to “dreamed up in China”-or from China as collaborator with the worldwide manufacturers on nothing to China as a low-cost, high-quality, hyperefficient collaborator with worldwide manufacturers on everything. This should allow China to maintain its role as a major flattening force, provided that political instability does not disrupt the process. Indeed, while researching this chapter, I came across an online Silicon Valley newsletter called the Inquirer, which follows the semiconductor industry. What caught my eye was its November 5, 2001, article headlined, “China to Become Center of Everything.” It quoted a China People's Daily article that claimed that four hundred out of the Forbes 500 companies have invested in more than two thousand projects in mainland China. And that was four years ago.
Japan, being right next door to China, has taken a very aggressive approach to internalizing the China challenge. Osamu Watanabe, chairman of the Japan External Trade Organization (JETRO), Japan's official organ for promoting exports, told me in Tokyo, “China is developing very rapidly and making the shift from low-grade products to high-grade, high-tech ones.” As a result, added Watanabe, Japanese companies, to remain globally competitive, have had to shift some production and a lot of assembly of middle-range products to China, while shifting at home to making “even higher value-added products.” So China and Japan “are becoming part of the same supply chain.” After a prolonged recession, Japan's economy started to bounce back in 2003, due to the sale of thousands of tons of machinery, assembly robots, and other critical components in China. In 2003, China replaced the United States as the biggest importer of Japanese products. Still, the Japanese government is urging its companies to be careful not to overinvest in China. It encourages them to practice what Watanabe called a “China plus one” strategy: to keep one production leg in China but the other in a different Asian country-just in case political turmoil unflattens China one day.
This China flattener has been wrenching for certain manufacturing workers around the world, but a godsend for all consumers. Fortune magazine (October 4, 2004) quoted a study by Morgan Stanley estimating that since the mid-1990s alone, cheap imports from China have saved U.S. consumers roughly $600 billion and have saved U.S. manufacturers untold billions in cheaper parts for their products. This savings, in turn, Fortune noted, has helped the Federal Reserve to hold down interest rates longer, giving more Americans a chance to buy homes or refinance the ones they have, and giving businesses more capital to invest in new innovations.
In an effort to better understand how offshoring to China works, I sat down in Beijing with Jack Perkowski of ASIMCO, a pioneer in this form of collaboration. If they ever have a category in the Olympics called “extreme capitalism,” bet on Perkowski to win the gold. In 1988 he stepped down as a top investment banker at Paine Webber and went to a leverage buyout firm, but two years later, at age forty-two, decided it was time for a new challenge. With some partners, he raised $150 million to buy companies in China and headed off for the adventure of his life. Since then he has lost and remade millions of dollars, learned every lesson the hard way, but survived to become a powerful example of what offshoring to China is all about and what a powerful collaborative tool it can become.
“When I first started back in 1992-1993, everyone thought the hard part was to actually find and gain access to opportunities in China,” recalled Perkowski. It turned out that there were opportunities aplenty but a critical shortage of Chinese managers who understood how to run an auto parts factory along capitalist lines, with an emphasis on exports and making world-class products for the Chinese market. As Perkowski put it, the easy part was setting up shop in China. The hard part was getting the right local managers who could run the store. So when he initially started buying majority ownership in Chinese auto parts companies, Perkowski began by importing managers from abroad. Bad idea. It was too expensive, and operating in China was just too foreign for foreigners. Scratch plan A.
“So we sent all the expats home, which gave me problems with my investor base, and went to plan B,” he said. “We then tried to convert the 'Old China' managers who typically came along with the plants we bought, but that didn't work either. They were simply too used to working in a planned economy where they never had to deal with the marketplace, just deliver their quotas. Those managers who did have an entrepreneurial flair got drunk on their first sip of capitalism and were ready to try anything.
“The Chinese are very entrepreneurial,” said Perkowski, “but back then, before China joined the WTO, there was no rule of law and no bond or stock market to restrain this entrepreneurialism. Your only choices were managers from the state-owned sector, who were very bureaucratic, or managers from the first wave of private companies, who were practicing cowboy capitalism. Neither is where you want to be. If your managers are too bureaucratic, you can't get anything done-they just give excuses about how China is different-and if they are too entrepreneurial, you can't sleep at night, because you have no idea what they are going to do.” Perkowski had a lot of sleepless nights.