DiligenceChina

A ‘China Inc.’ model is emerging that can predict that behavior of future Chinese business trends and organizational behavior. We all remember ‘Japan Inc’, and then the ‘4 Tigers’ (or the ‘4 Little Dragons’, depending on which magazine you read). These were general models that described the broad trends in those economies as they developed and engaged with international markets. Up until now, many commentators and writers have been referring to China’s ongoing ‘privatization’ as if it were the dominant model – and then backtracking, qualifying, explaining and generally performing all manner of semantic acrobatics to reconcile their theories with actual practice. China is not privatizing – at least not in the way that western economists and market watchers desperately want to believe it is.

The model that is emerging is a new kind of State Entrepreneurship. It is a refinement of the old-style SOE (State Owned Enterprise) system – not a replacement or privatization. Bureaucratic and administrative ‘direction’ has replaced politburo mandates, but the means of production are still organized by a central authority. China Inc. cooperates well with international markets, allows foreign companies and individuals to make lots of money, and is a strong and reliable trading partner. It is technocratic, rational, and fairly efficient (considering its size, scope and mandate). What it is NOT is privatized, and anyone who thinks it is ever going to be will have a real problem when China’s growth numbers go to single digits – which should happen some time this year after the first dip in US/International demand for inexpensive manufactured goods. China Inc. is not private in any significant sense of the word, never will be, and will punish those that fool themselves into believing it is.

Now, here’s the tricky bit: If the notion of a statist entrepreneurial China Inc. model is a problem, then it’s YOUR problem. China is OK with it, and always has been. In fact, they have been fairly open, frank and methodical about it. They aren’t pulling the wool over anyone’s eyes – its western investment bankers, management consultants and Chundits (China pundits) who have promoting the “more Capitalist than New York” image. I do a lot of consulting for sales teams and Chinese investor relations departments, and I can’t get these guys to shut up about their cozy ties with the government. They think it’s the greatest thing since sliced bread. The Chinese business community considers this is obvious to everyone, and suspects western investors are either a little dim or have some kind of double-reverse secret-fake up their sleeves when they dump investment funds into this market. It’s only the western media that even talks about privatization and individual entrepreneurship. Locals are still talking to one another about how to get the most out of government ties. Due largely to the efforts of people like me, they have learned to shut up about it when speaking to YOU. (Sorry.)

I’ll go into more detail about the nature of the China Inc. model in coming posts, but let’s take a look at some of the implications of State Entrepreneurship.

Implication 1: China Inc.’s structure is more analogous to Singapore than to Japan but that is little more than a coincidence. The size, scope, level of development and population precludes close control of the big economic trends. The levers of policy have a very long lead time, and due to China’s legal structure and governmental organization, are not very precise. Just because you think the government is heading in the right direction and passing the right policies doesn’t mean you’re excused from doing your due diligence and developing a variety of bad & worst-case scenarios. (Same is true in US, Europe and everywhere else – but for some reason people don’t do their homework when they come to China.)

Implication 2: China Inc. works on a Stakeholder model, not a Shareholder model. Ultimate responsibility is to policy-makers, not profit-oriented shareholders. Stop looking for economic rationality, and start figuring out what political rationality is. China Inc. isn’t on its way to becoming a logical system – it already is, but with goals that may not align with traditional economics.

Implication 3: China’s banking system is bad – but not dysfunctional. It is operating the way it is supposed to – executing a policy of supporting centrally directed companies. There is a lot of pressure on Chinese banks to look like there is a lot of pressure on Chinese banks. The reality is that they are in no danger of losing their mandates – unless they stop serving an effective policy function. Investors who are placing big bets on the Big Banks becoming more competitive and nimble may be in for some pain.

Implication 4: Corruption is the “statist dividend”. It is not going away. Recent headlines reflect political realignment, maneuvering and reigning-in of those who have gone too far. Chinese managers have always viewed what you and I call ‘corruption’ as a just reward for hard work and heads-up thinking – not mafia-style crime. They don’t understand what all the fuss is about.

Implication 5: Revenge of the angry Market doesn’t mean as much in China as it does in other economies. There are no elections here, no shareholder revolts, no piper to pay. Policy makers are rewarded for digging in and resisting change in the face of external pressure – be it international opinion or economic recession. As long as the integrity of the ruling party structure isn’t directly threatened, this system has tremendous tolerance for pain and suffering. They like it – as long as everyone is feeling it. Don’t let us Shanghai wimps give you the wrong idea – most of China prides itself on its ability to endure tremendous hardship.