70 INC.MAGAZINE MARCH 2005 - Western Oregon Universityeltonm/Marketing Strategy/How China will change yo… · Contrary to common wisdom, however, the trade deficit with China does

70 INC.MAGAZINE MARCH 2005

THE PEARL OF THE ORIENT

Pudong, Shanghai's iconic glass skyline, is home to nearly 6,000 foreign-funded businesses, which take

advantage of its status as a Special Economic Zone. Projects on the boards include the world's tallest

building, the world's largest shipyard, and a Ferris wheel that will dwarf England's London Eye.

CHINA'S MIRACLE ECONOMY can come at youin a lot of ways, from all directions.

• Mention an interest in China to your old friend who ownsan industrial toolmaking shop and he confides that his facto-ry, which was started by his father and has bought a comfort-able suburban life for three generations of his family as well asgood wages to hundreds of workers, "is getting kiiied by thepeople over there."

• Stop at the auto supply store for windshield-wiper fluid.Half the store is now a showroom tor small Chinese motorscooters, some of which look like half-Harleys, others likeDucatis. Most cost iess than $300.

• Decide at last to plunge into digital photography. Photomagazines all rave about a small new camera from Nikon, anengineering wonder that can shoot fast, captures dimly litscenes, and costs half the price of similar machines a year ago.Nikon is one of Japan's marquee brands, but when you bringthe camera home from the store you spot the words in smallprint on tbe product itself: "Made in China."

• Wake up in Santa Barbara, Calif., one morning to a sky thatlooks as though it is painted a shiny white. The morning'snewspaper reports that the sunlight is playing tricks on some-thing known as the Asian Brown Cloud, a mass of dust that has

drifted over the Pacific from China. The cloud contains parti-cles of loose earth from deforested land mixed with arsenic andother industrial pollutants from the country's factories.

POWERED BY THE WORLD'S MOST rapidly changing large econo-my, China is an ever increasing presence and influence in our lives,connected to us by the world's shipping lanes, fmancial markets,telecommunications, and above all, by the globalization of ap-petites. China sews more clothes and stitches more shoes and as-sembles more toys than any other nation. It has become the world'slargest maker of consumer electronics, pumping out more TVs,DVD players, and cell phones than any other country. And morerecently, it has ascended the economic development ladder high-er still, moving quickly and expertly into biotech and computermanufacturing. It is building cars (there are more than 120 auto-makers in China), making parts for Boeing 757s, and exploringspace with its own domestically built rockets.

Americans tend to focus on the huge inequality in trade be-tween the two countries. It is a worry Americans help to createby buying ever more from China's humming factories. In 2004,the Chinese sold the United States $ 160 billion more in goods thantbey bought. Contrary to common wisdom, however, the tradedeficit with China does not mean that Americans are spending

72 INC.MAGAZINE ' MARCH 2005

OHtNA

MADE IN CHINA

China will continue to offer Americans more bargains as time goes forward because the

vast majority of U.S, imports stilt come from countries that pay relatively high wages.

Above: A worker at the Shanghai Mei Li Hua flag factory

down the national wealth at a faster pace than ever before. Sofar, most of China's gains with American buyers have come attbe expense of the other countries that once lured American dol-lars, especially other Asian economies. Americans—and theworld—get more stuff in the bargain.

Ever since Cbina started on the capitalist road, opinions aboutits prospects bave figuratively, and literally, been all over the map.The present mood is a combustible mix of euphoria, fear, admi-ration, and cynicism. On tbose emotions ride great tides of cap-ital, tbe strategic plans of businesses great and small, and tbegravest political calculations in tbe world's capitals and city halls.

Yet few working Americans have a full awareness of China'srise. How could they? Nothing like this bas ever happened be-fore, and it's occurring on the other side of the globe. Yet Amer-icans—particularly anyone involved in running a business—needto know what is happening today in China and to understand howChina's fate has become inextricably bound with our own. Con-ceding China's rise does not mean conceding to China. But it doesrequire acknowledging some important truths;

1 China's economy is much larger Ihan the official numbersshow. In 2003, China's official GDP was $1.4 trillion. By thatmeasure, it was tbe seventh-largest economy in the world. As with

nearly all economic statistics from China, however, that meas-ure is suspect. One reason the real number may be much higheris tbat, in competition for development funds, local Chinese au-thorities have considerable incentive to underreport their growthrates to the nation's central planners. Another reason is that thegovernment measures only China's legal economy. Its under-ground economy, made up of both unsavory businesses and moremundane ones that lack a government stamp (and tax bill), isenormous but uncountable.

Economists also note that China's official GDP underplays thetrue size of its economy because China uses the massive powerof its foreign currency reserves to keep the world price of the yuanmarching in lockstep with the dollar. If the dollar bad not droppedagainst the euro and other world currencies over the past fewyears, China's ranking would be a notch or two bigber. Critics ofChina's currency policies, including American domestic manu-facturers such as steel mills, casters, plastics molders, and ma-chine-tool makers, argue that China artificially depresses the valueof its currency against the dollar by as mucb as 40%.

A dollar spent in Cbina buys almost five times more goods andservices than a dollar spent in a typical American city like Indi-anapolis. Taking purchasing-power parity into account, the U.S.Central Intelligence Agency estimates that China's economy looks

MARCH 2005 INC.MAGAZINE 73

COMPETITION BY THE BOATLOAD

A 2003 survey of Illinois manufacturers found that 13 out of every 20 firms face competition from China.

Of those affected, 84% stated that Chinese competition hurt their sales by an average of at least 17% that year,

Ahove: Hapag-Lloyd's Hong Kong Express, one of the iargest vessels in the world, docks at Kwai Chung container terminal.

more like one with a GDP of $6.6 trillion. Put anotber way, itmakes more sense to think of China's economy as closer to two-thirds the size of the U.S. economy than to one-seventh.

2. The growth of China's economy has no equal in mod-ern history. China's economy has grown so fast that it has tak-en on themythicqualitiesofoneof Mao's showcase farms. SinceChina set about reforming its economy a generation ago, its GDPhas expanded at an annual rate of 9.5%. Countries in the earlystages of economic reform often come up fast, but not like Chi-na. The country is closing in on a 30-year run during which itseconomy has doubled nearly three times. Neither Japan's norSouth Korea's postwar boom comes anywbere close. NicbolasLardy, an economist at tbe Institute for International Econom-ics, notes that China grew mightily even during the worldwideeconomic doldrums of 2001-02.

China is so committed to economic growth that the Chineseoften talk as though they can will it to happen. It is a necessaryoptimism that pervades official Chinese communication. OrvilleSchell, the author of Virtual Tibet and the dean of the school ofjournalism at the University of California, Berkeley, draws a par-allel between the unity of focus the Chinese demonstrated for an-ticapitalism and their focus now on capitalism. Schell argues tbat

in both instances tbere is a willingness to suspend logic and seeonly bright tomorrows. Both iead to excess. In its capitalist pres-ent, Cbina has been willing to overlook the dark side of modern-ization, seeing economic progress as tbe solution to all thecountry's challenges. Even so, every time the worst is predictedfor China's economy, it seems to grow faster, create stronger in*dustries, import more, and export more.

3. China is winning the global competition for investmentcapital. One reason China's economy is growing so fast is tbat theworld keeps feeding it capital. According to Japan's Research In-stitute of Economy, Trade and Industry, one-third of China's in-dustrial production was put in place by tbe balf-trillion dollarsof foreign money that has fiowed into the country since 1978.In 2003, foreigners invested more in building businesses in Chi-na than they spent anywhere else in the world. The U.S. used toattract the most foreign money, but in 2003 Cbina took a stronglead, pulling in $53 billion to the U.S.'s $40 billion.

With money comes knowledge. Tbe catalytic role of foreign-ers in the country is still growing quickly; every day China receivesa river of European, Asian, and American experts in manufac-turing, banking, computing, advertising, and engineering. In2003, tbe exports and imports by foreign companies operating

74 INC.MAGAZINE MARCH 2005

CHINA

LOWER PRICES: DIRECT FROM CHINA

If it were a nation, Wal-Mart would now rank as China's fifth-largest export market,

ahead of Germany and Creat Britain. Usually the dominatU customer of the factories that serve it,

the retailer commands an unmatchable power to set prices.

in China rose by over 40%. More than half of China's trade isnow controlled by foreign firms. Many of these import goods intothe country that they then manufacture into exports. Foreigncompanies have pumped up China's trade volume enough tomake it the third-largest trading country in the world, bebindthe U.S. and Germany and now ahead of Japan.

4. China can be a bully. China can spend, it can hire and dic-tate wages, it can throw old-line competitors out of work. In justa three-year period from 2000 to late 2003, for example, China's ex-ports to the U.S. of wooden bedroom furniture climbed from $360million to nearly $1.2 billion. During that time, tbe work force atAmerica's wooden-furniture factories dropped by 35,000, or oneof every three workers in tbe trade. Cbina now makes 40% of allfurniture sold in the U.S., and that number is sure to climb.

5. China's economy is an entrepreneurial economy. Cbina sindustrial competitors, including the U.S., often misapprehend thesource of China's productive strength. They fear that another cen-trally governed, well-planned assault on strategic industries is be-ing plotted in Beijing. The world has already seen how effective theJapanese, Koreans, and Taiwanese can be when they focus on sec-tors they mean to conquer. Even Chinese government planners like

to talk as though they are aping the centrally coordinated, gov-ernment-financed assaults on strategic global industries that theirAsian neighbors have pulled off over the past 40 years. However,in looking at how Chinese businesses really take shape—locallyand opportunistically—Kellee Tsai, a political scientist at JohnsHopkins University and a former analyst at Morgan Stanley, ar-gues tbat notbing could be further from the trutb. For a world fret-ting over Chinese economic competition, the entities to fear arenot government planners but enterprises that spring on tbe scenelean and mean, planned and financed by investors who want tomake money quickly.

An emblem of tbe Zbejiang province in Cbina is HongDongyang, an entrepreneur whose story is now well-knownthroughout the country. Hong was once a schoolteacher. She be-gan making socks in the 1970s on a home sewing machine. Atfirst Hong sold them along the roads near her home. She openeda stand and christened her embryonic enterprise Zhejiang Stock-ing Company. Hong's sock company was predictably copied enmasse by otbers. Today, tbe province is tbe Cbinese sock capital,with more than 8,000 companies spinning out eight billion pairsa year, one-third of the world's supply. In 2001, the Chinese mak-ers produced 1% of tbe socks on U.S. feet. In just two years, sockimports from China to the U.S. jumped two-hundred-fold and

MARCH 2005 INC.MAGAZINE 75

now make up 7% of the U.S. market, lames ]. lochum, assistantsecretary for export administration at the U.S. Department ofCommerce, has noted that the Chinese manufacturers cut theirprices by more than half in 2003 and helped drive one in fourU.S. sock makers out of business.

6. The most daunting thing aboutChina is not its ability to make cheapconsumer goods. The American econ-omy won't crater just because the Chinesecan produce sofas and socks for less thanwe can. The Japanese, for their part, havelost the television business. The Italiansare losing tbe fine-silk business. Con-sumer goods trade on tbe surface of theworld's economy and their movement iseasy for the public to watch. The far big-ger shift, just now picking up steam, is oc-curring among the products thatmanufacturers and marketers trade witheach other: the infinite number and va-riety of components that make up every-thing else that is made, whether it is thehundreds of parts in a washing machine

or computer or the hundreds of thousands of parts in an airplane.Given how quickly China is climbing the industrial ladder,

perhaps the next question is whether any commercial technol-ogy is beyond an imminent challenge from Cbina. Gal Dymant,an American Israeli venture capitalist in Beijing, believes tbe an-swer is tbat few will be. One of the companies Dymant workswith, a database publisher named Asia Direct, produces an an-nual China Hi-Tech Directory. Tracking tbe directory's updatesyear to year gives Dymant an informal measure of the shifts inChinese industry.

The first thing one notices about the directories, he says, is howmuch thicker they grow every year, particularly in industrieswhere there have been large foreign investments. In 2003, Asia Di-rect's volume grew considerably fatter in the sections devoted toChina's domestic mobile-phone manufacturers and suppliers,broadband communications, and in companies establishingthemselves in cities outside of China's eastern powerhouses. Themanufacture and sale of integrated chips is also soaring, alongwith healthy gains in China's software and information-servicesmarkets. Then again, every section in the directory has grown, in-cluding biotechnology, semiconductors, and Internet develop-ment, areas in which Chinese firms have newly establishedthemselves, many now in partnership with the world's leadingtechnology-driven companies.

For his part, Dymant is putting together an investor group tobuildaCbinese version ofoneofthe world's most advanced andcostly medical devices, the magnetic resonance imaging (MRI)machine."The talent is here to build anytbing," Dymant says."Wethink we can develop MRIs for about 60% of the price they arebuilt for in the U.S."

7. China is closing the research and development gap—fast. The ability of American industry to stay ahead of its inter-national competition rests on the national gifts and resources thatthe U.S. devotes to innovation. The research gap between the U.S.and China remains vast. In December, Washington authorized $3.7

The Cycle ofCodependency

China is at one moment

our greatest threat, the next our friend.

It is siphoning off American jobs; it is essential

to our competitive edge. China exports

deflation; it stokes soaring prices.

China pegsthe yuan at a

discount to theU.S. dollar

billion to finance nanotecbnology research, a sum the Chinese gov-ernment cannot easily match within a scientific infrastructure thatwould itself take many more billions {and years) to build.

Yet when it conies to more mainstream applied industrial de-velopment and innovation, the separa-tion among Chinese, American, andother multinational firms is beginning tonarrow. Last year, China spent $60 billionon research and development. The onlycountries that spent more were the U.S.and Japan, which spent $282 billion and$104 billion, respectively. But again, Cbi-na forces you to do the math: China's en-gineers and scientists usually makebetween one-sixtb and one-tenth whatAmericans do, which means that the wide

gaps in financing do not necessarily resultin equally wide gaps in manpower or re-sults. The U.S. spent nearly five timeswhat China did but had less than twotimes as many researchers (1.3 million to

743,000). China's universities and vocational schools will pro-duce 325,000 engineers tbis year—five times as many as the U.S.

For now, the empbasis in Chinese labs is weighted over-whelmingly toward the "D" side—-meaning training for technicalemployees and managers. Nevertheless, foreign companies aremoving quickly to integrate their China-based labs into their glob-al research operations. Motorola alone has 19 research labs in Chi-na that develop technology for both the local and global markets.Several of tbe company's most innovative recent phones were de-veloped there for the Chinese market.

8. China now sets the global benchmark for prices. Bignews can be found in littie places. In its November 2003 circular,a dryly written four-page publication, the Cbicago Federal Re-serve Bank noted complaints from American makers of automo-tive parts that "automakers had been asking suppliers for the 'Chinaprice' on tbeir purchases." The bank's analysts observed that U.S.suppliers had aiso been asked by tbeir big customers to move tbeirfactories to Cbina or to find subcontractors tbere.

Over much of the business world, tbe term China price hassince become interchangeable with lowest price possible. TbeCbina price is part of tbe new conventional wisdom that com-panies can move nearly any kind of work to China and find hugesavings. It holds that any job transferred there will be donecbeaper, and possibiy better.

It is plainly understood tbat asking suppliers to lower pricesis merely another way of telling them they ought to be preparedto meet the best price out of China, even if they are making theirproducts in Japan or Germany. General Motors, which buys morethan $80 billion worth of parts a year, now has a clause in its sup-ply contracts that gives its supplier 30 days to meet tbe best pricethe company can fmd worldwide or risk immediate termination.

In fact, in tbe U.S. between 1998 and 2004, prices fell in near-ly every product category in which China was the top exporter."The manufactured goods that have dropped in price the most

Continued on page 80

76 INC.MAGAZINE MARCH 2005

Cheap yuan makeU.S. industriesthat produceanywhere but

China lesscompetitive

Depressed yuanleads to a dollar

that is loweragainst other

currencies, such asthe euro

f A cheaper dollar >:makes foreign J

travel for 'Americans more

expensive (exceptto China)

As the dollar gelcheaper, foreignfirms will investmore in the U.S.

I U.S. bargainingpower would

diminish

U.S. factories haveto compete against

less expensiveChinese goods

U.S. businessesthat manufactureor source goods in

China can profitfrom cheap

supply chains

Cheap computersand other infor-mation devices,

now made in China,allow U.S.

businesses tostreamline and

automate

High volume of '^sales of goods to

U.S. buyers boostsChina's dollar

reserves

Manufacturingworkers lose

their jobs

China pursuesmore U.S. bondsand other debt

U.S. interest ratesdecline or stay low

Prices of finishedgoods in the U.S.

decline

U.S. consumers getmore bargains

Cheaper pricesinduce more buying

DisplacedAmerican workers

have difficultyfinding jobs

comparable inpay to those

they lost

Low interest ratesencourage U.S.

consumer spendingand debt, and

discourage savings

Consumer debt

Low rates makeit easier for

businesses toborrow and grow

Increased spendingby businessesincreases the

demand for theservices of small

and entrepreneurialfirms that providebusiness services

and products

Ifthe U.S. dollsinks too low,it could lose its

privileged role asthe world's reservecurrency, possiblyraising the cost

and risks of doingbusiness with

American firmsover the long haul

Increasedfor finished goodsfrom China drivesup the prices for

commodities(metals, plastics,

fibers)

Cheap moneyallows the U.S.government todeficit-spend

: LChinese banks also

keep rates low,propelling China'sdangerously fast

and loose industrialdevelopment—lead-ing to overcapacityin nearly everything

its industriesmanufacture

Graphic by Tommy McCall MARCH 2005 INC.MAGAZINE 77

CHiNA

yimminent

hllminent

challenge

ina.

Continued from page 76are those made by China," says W. MichaelCox, chief economist for the Federai Re-serve Bank of Dallas, citing figures assem-bled by the bank for its 2003 annual report,published in 2004. Personal computers, themost outstanding example, fell by 28%, tel-evisions by nearly 12%, cameras and toysby around 8%, while other electronics,clothing of all sorts, shoes, and tablewarealso dropped in price.

9. China's growth is making raw ma-terials more expensive. Even as Chinaputs pressure on U.S. manufacturers tolower prices, it's squeezing them from a dif-ferent direction. Its voracious demand forraw materials has caused prices to spike. Copper prices jumped37% last year, aluminum and zinc both rose about 25%, and oilwas up 33%. In 2003, according to the calculations of StephenRoach, chief economist at Morgan Stanley, the Chinese bought7% of the world's oil, a quarter of all aluminum and steel, near-ly a third of the world's iron ore and coal, and 40% of the world'scement. The trend is for bigger amounts yet to come.

The squeeze is leaving U.S. manufacturers with no alterna-tive but to become more productive. Better machines, software,and advanced management techniques, for instance, now meanthat U.S. companies on average produce far more per workerthan they did a quarter of a century ago when manufacturingemployment was high. From 1977 to 2002, productivitythroughout the U.S. economy grew by half, but in manufactur-ing it more than doubled. Surprisingly, despite losing huge num-bers of workers, U.S. manufacturers actually finished 2003making more stuff than they did in 2001. Output was up, ifonly by half a percent.

10. No company has embraced China's potential more vig-orously than Wal-Mart. And no company has been a biggercatalyst in pushing manufacturers to China. Estimates of howmuch of Wal-Mart's merchandise comes from abroad todayrange from 50% to 85%. Chinese factories are, by far, the mostimportant and fastest-growing sources for the company. In 2003,Wal-Mart purchased $15 billion worth of goods from Chinesesuppliers. A whopping portion of between 10% and 13% ofeverything China has sent to the U.S. winds up on Wal-Mart'sshelves. Writing in The Washington Post, Peter Goodman andPhillip Pan reported in February 2004 that "more than 80% ofthe 6,000 factories in Wal-Mart's worldwide database of suppli-ers are in China." The company has 560 people on the groundin the country to negotiate and make purchases.

Wal-Mart is often demonized for its part in shipping U.S.manufacturing jobs overseas. It is difficult, however, to sepa-rate the role of Wal-Mart's thousands of suppliers in the mi-gration of manufacturing out of the U.S. from the larger globaltrends realigning how and where the world makes things. If Wal-Mart has a unique part in the trend, it is in how expertly the com-pany has managed that trend and, in so doing, accelerated it.China's low-cost manufacturing machine feeds Wal-Mart's crit-ical mass by allowing companies to build assembly lines thatare so huge that they achieve ever-greater economies of scale and

The nextquestion iswhether gnycommercialtechnology is

l: yor)d anm m n t

drive prices downward all the more.Wal-Mart's Chinese suppliers can

achieve startling, market-shaking pricecuts. By selling portable DVD players withseven-inch LCD screens from China forless than $160, for instance, Wal-Mart re-cently helped cut the price of these trendydevices in half. F,ven with superlow prices,Chinese factories can sell in such giantquantities that they willingly oblige. To getready for its big Thanksgiving sale in 2002,Wal-Mart picked Sichuan ChanghongElectric, one of the world's largest makersof televisions, to supply sets under theApex Digital brand. Changhong makes 15million TVs a year, most of them for ex-port. Eight of 10 shipped overseas go to the

U.S. In 2002, its sets at Wal-Mart sold for far less than compa-rable models from other makers, sometimes undercutting thecompetition by $100 or more. The models the company deliv-ered for the sale helped the event net $ 1.4 billion.

In late December, state-owned Changhong reported nearlyhalf a billion dollars in losses, purportedly linked to unpaid billsowed by Apex. The scandal, though mired in murky details, nev-ertheless highlights both the ability of China's big firms to sus-tain losses and keep running and their willingness to satisfyAmerican retailers' demands for ever-lower prices.

11. There are hidden costs associated with doing busi-ness in China. Companies that engage with China must expectpressure to transfer their technology and thus create their owncompetition in the country. The Chinese use the carrot of theirvast market to extract concessions from foreign firms that willhelp build China's industrial might. It is a policy worthy of grudg-ing admiration. When viewed from the Chinese side, it has alongrecord of success.

Motorola virtually invented China's mobile-phone market. Itscorporate archives show that the company knew that eventuallythe transfer of technology to China would sow formidable ri-vals. Nevertheless, Motorola decided its best strategy was to getinto China early and to bring its best technology. The proof to-day is in the size and efficacy of the country's mobile commu-nications network: Calls get through to phones in high-rises,subway cars, and distant hamlets—connections that would stymiemobile phones in the U.S.

What no one at Motorola anticipated was how crowded theChinese market would become. Nokia and Motorola now bat-tle for market share in the Chinese handset business. German,Korean, and Taiwanese makers figure strongly. And all these for-eign brands are now facing intense competition from indige-nous Chinese phone makers. More than 40% of the Chinesedomestic handset market now belongs to local companies suchas Ningbo Bird, Nanjing Panda Electronics, Haier, and TCL Mo-bile. The domestic makers have become so strong that whenSiemens found its mobile handset business in China wanting,it joined with Ningbo Bird to gain both low-cost manufactur-ing and a developed distribution channel. Yet Motorola can't exitthe Chinese market. If it did, says Jim Gradoville, Motorola's vicepresident of Asia Pacific government relations, the Chinese com-

Continued on page 84

80 INC.MAGAZINE . MARCH 2005

Continued from page 80panies that emerged would be the leanestand most aggressive in the world, and acompany like his would have no idea whathit it. So Motorola stays. Already the largestforeign investor in China's eiectronics in-dustry. Motorola plans to triple its stakethere to more than $ 10 billion by 2006.

people ofQnina a

12. Piracy is a problem. Foreign compa-nies have little defense against even outrighttheft of their technology in China. China'sfailure to police intellectual property, in ef-fect, creates a massive global subsidy worthhundreds of billions of dollars to its businesses and people. Byinvesting in the country's manufacturing infrastructure, by pro-viding the expertise, machines, and software China needs to pro-duce world-class products, the world is also helping assemblethe biggest, most sophisticated, and most successful "illegal" man-ufacturing complex in the worid.

Seen another way, China's loose intellectual property rulesturn the tables on the Western colonial powers and the Japan-ese who throughout the nineteenth and early twentieth centuriesviolated China's land and people. As China grows into a greatpower, the wealth transferred into the country by expropriat-ing intellectual property will propel it forward.

13. China's heavy buying of U.S. debt has lowered the costof money in the U.S. In the tlrst half of 2004, China's totalforeign exchange reserves topped $460 billion. In size, that putsChina's cumulative dollar account at roughly equal to a thirdof its gross domestic product. If China simply spent its dollars,it would flood the world market with American currency anddrive the dollar down. But China, no fool, is not interested inpushing the dollar down. So instead of selling its dollars, it lendsthem back to the U.S.

China keeps tight wraps on the value, composition, and trad-ing of its portfolio, but Wall Street commonly assumes that thecountry owns a large amount of high-grade U.S. corporate bonds,intertwining its national fortunes with America's blue chips (manyof them the same corporations reaping fortunes in China itself).

China also has almost certainly built a large stake in the mar-ket for bonds issued by Fannie Mae and Freddie Mac, the com-panies that buy home mortgages from hanks and thriftinstitutions and resell them as bundled securities. This means thatbillions of dollars' worth of investments belonging to the Chineseare plowed indirectly into the American real estate market, andthat an ever-increasing share of Americans' mortgage paymentspour into the coffers of the government of China.

As long as China is an aggressive lender, Americans—whetherborrowing for their own private purchases or acting in the rolesof taxpayers^can borrow money at lower rates than they wouldotherwise have to pay. Much of the recent boom in real estateprices in America, especially in the East and West Coast mar-kets, is attributable to these low rates.

14. Americans and Chinese have become reliant on eachother's most controversial habits. The Chinese need a low-priced currency to keep their export machine going and createjobs. But maintaining the yuan's low price also means that Chi-

inaisups

the insa iaDieshopping ofAmericans.

nese consumers are stuck with a currencythat would otherwise buy more for them onthe world market. China's diligent saverssuffer too since their bank deposits are tiedup in accounts that earn low government-mandated rates of return, as the govern-ment, in effect, siphons off money fromsavers to maintain its currency peg.

Rclatedly, China's vast export earningsearn less than they ought to when they are in-vested in U.S. debt securities that offer mod-est yields, when investments in the Chineseeconomy can return 10 times as much (al-beit on riskier terms). Seen from that view,

the people of China, who earn on average just one-fortieth whatAmericans do, are indirectly subsidizing the insatiable shoppingof Americans, who acquire ever more goods at the same time thatChinese consumers are hampered from buyinggoods from abroad.

The obverse of this peculiar relationship is that China lendsAmerica ali the money it needs to spend itself silly. The cycleof codependency, which former U.S Treasury SecretaryLawrence Summers labels a "balance of fmancial terror," isn'tsustainable. The U.S. cannot take on ever-bigger debt and amasshuge trade deficits indefinitely. In the worst scenario, the U.S.'swillingness to fritter away its national wealth to finance privateconsumption and unproductive government spending wouldextract a permanent price on the economy, sending the U.S. ina downward spiral that wouid be hard to escape.

Thus do the routes to prosperity chosen by China and theU.S. put both countries at risk. Without the U.S. to buy Chinesegoods, China cannot sustain its growth; without China to lendmoney to the U.S., Americans cannot spend. Without the twin en-gines of the U.S. and China stoking the fortunes of other na-tions, the rest of the world might also sputter.

HOW CAN THE U.S., PERHAPS WITH its traditional allies, adjustto a competitive challenger that has strengths unlike any otherthat America has faced? Are the transfers of talent, technology,and capital part of an inevitable dynamic? Or does the U.S., orany other country, have the power to shape a future in whicheveryone prospers?

Americans looking for answers and action must also find a wayto move America's leadership to see China's rise as every bit asworthy of national attention as the rumblings in more obviouspolitical hot spots. While all eyes turn to the so-called clash of civ-ilizations between Islam and the West, China will have the moreprofound impact on the world in the long run. And yet, despiteoccasional misgivings offered in factory towns and tariffs slappedon imports at the height of campaign season, American leaderstend to view China's rise as the fulfillment ofa free marketer'sdream, where global investors will shepherd the country intowealth, democracy, and peaceful interdependence with the rest ofthe free world.

It is a lovely theory, and it may ultimately be true. There is,however, no evidence upon which to base such a prediction.Which exactly of the world's large, highly nationalistic, dictato-rial. Communist-capitalist countries offers a historical analogue?Answer: There is no such country. O

This article was adapted from Ted C. Fishman's book, CHINA, INC., published byScribner, an imprint of Simon & Schuster.

84 INC.MAGAZINE MARCH 2005